Office In Home and Mileage Deductions

There is often a lot of confusion surrounding an office in home and the mileage deduction and the difference between commuting and business miles.  I have heard many accountants over the years selling the deductions like in an infomercial, claiming that by simply setting up an office in the home used exclusively for the business that it will amazingly increase their auto deduction by 60%.  Plus, if you act now, they will throw in an exclusive tax table mouse pad and two free months of the tax savings newsletter…

Seriously though, while an office in home can increase your auto deduction in many cases, it is unfortunately not that simple – as is the case with the majority of IRS rules.  It is very important you understand all the requirements so that you can maximize your deduction without exposing yourself to audit risk.

I am not going to get into the details of business vehicle expenses in this post, but in general terms, business use of a vehicle does not includes personal or commuting miles.  Whether you use the standard mileage rate or the actual expense method, your deduction is limited to actual business use – which will be calculated based on your mileage log or reports from your mileage calculator app (for you iPhone enthusiasts).  For your standard business owner with rented office space outside the home who does not perform substantial administrative and management activity from a home office, the miles to and from the office each day are not deductible.  Depending on the business owner’s commute, this can be a significant portion of overall vehicle use, so you can see why this is a crucial issue.

How can these commuting miles be turned into business miles?

Well, it can be a bit complex when reading IRS Pub 587 as there are many requirements and exceptions, so I set up this office in home deduction mind map using FreeMind software, which walks through the first few pages of IRS Pub 587 and lays everything out visually.  If you look at the first three requirements, you’ll notice that you have probably heard about them before if you have a general understanding of the office in home.  Exclusive, regular, and business use are usually what most people focus on because the classic example you think of with office in home is the sole proprietor who uses their home as the sole business location.  However, most small or micro-businesses have office space at a location outside the home, so the fourth requirement that the home office be the principle place of business is the most crucial issue.  If this requirement can be met either through an exception or by re-arranging your business operations, then you have a qualifying office in home and mileage from that office to other business locations would qualify as business mileage.

How can you satisfy the principle place of business requirement?

In order for your home office to be considered the principle place of business, it must be used exclusively and regularly for administrative and management activities including:

  • Billing customers, clients, or patients
  • Keeping books and records
  • Ordering supplies
  • Setting up appointments
  • Forwarding orders or writing reports

This means that it must be the only location that these administrative and management activities are conducted.  However, there are some exceptions to this rule and situations where it is permissible for these activities to be performed outside of the office in home :

  • service providers can conduct administrative activities at other locations (payroll service, etc);
  • management and administrative work done in a non-fixed location like a car or hotel room is permissible;
  • administrative activities can be conducted at a fixed location outside the home office if occasional and minimal;
  • substantial non-administrative, non-management activities can be performed outside the home;
  • and even if suitable space is available outside the home for administrative and management activities, you can still choose the home office as the primary location for these activities.

If your home office does not qualify for any of these exceptions and is not the principle place of business, there are still two more exceptions that could help you:

  • If you physically meet with clients, patients, or customer in you home office – and it is substantial and integral to your business;
  • or your home office is a separate structure from the dwelling unit.

Meeting either of these exceptions will qualify your office in home even though it is not the principle place of business.  Again, this would make your mileage from the home office to the other business office deductible as business miles.  This can create significant tax savings, but you have to make sure you have a solid position as this issue does often come up in IRS audits.

Let’s look at an example…

Dr. Bob is a dentist who has two dental offices in the metro area and his commute is significant since he lives far outside the city.  Without a qualifying office in home, the commute to the an office and the commute home are personal and are non-deductible commuting miles.  Any trips made between the offices or for other business purposes during the day are deductible, but that long commute that is a majority of the miles driven is personal.

Now let’s assume that Dr. Bob has a large bonus room that he converts into a home office.  The office is not separate from his house, and he does not meet with patients at his home (for a number of reasons), so he must make the home office be the only place for administrative and management activities or meet one of the exceptions.  If Dr. Bob uses a third party service provider for billing and factoring, he and his wife complete the bookkeeping in QuickBooks at the home office, and his wife sets up appointments from the home office – then I think he would have a very solid position for a qualifying office in home and the mileage from the home office would be deductible.  However, if all the billing is done internally at one or both of the dental offices, or if an internal bookkeeper does a majority of bookkeeping at one of the dental offices, or the office managers at the two offices setup up all the appointments – then I think Dr. Bob is going to have a very weak case for arguing that his home office is the principle place of business.

Every case is going to be different and most business owners are not going to have clear-cut circumstances like our Dr. Bob; however, it is very important you go over this in detail with your CPA or accoutant to make sure you have a solid position for the auto expenses you are claiming.  With the technology available today, many business owners should be able to arrange their business so that the requirements are met.

If you like to discuss this with me or need help in laying out a strategy to maximize your tax deductions, feel free to email or call me at 503.244.8844 to find out more about our consulting services.

Travel Expenses and Business Planning Trips

It is the that time of year again, when most people are on vacation – or at least they wish they were.  With the current heat wave in Portland, many would probably go for an Alaskan cruise right about now.  Whether it is colder weather you are looking for or a tropical paradise, if you are business owner, you should talk to your CPA or accountant about business planning trips and travel expense rules to make sure you are maximizing your deductions without getting too aggressive or raising your audit risk.

Whether you have an LLC, S-Corporation, Corporation, or a Single-Member LLC – you should consider an annual business planning meeting where you can get away from the everyday distractions that steal your focus and layout out your short and long term goals and strategies, look into new products or technologies, and brainstorm solutions for overcoming obstacles and bottlenecks in your business.  Without even getting into taxes, this makes sense from a marketing standpoint and would seem vital for a business to continue to thrive and grow.  Unfortunately, IRS agents are anything but marketers, so you have to make sure your deduction is well supported.

How do you maximize travel deductions that are also well supported before the IRS?  Here are my recommendations:

  • To write off the actual travel expenses to and from the destination, the trip must be related primarily to the taxpayers business.  If the trip is primarily personal in nature, then these costs are not deductible and only the expenses incurred while at the destination allocable to the business are deductible.
  • Document in detail all the business planning you completed on the trip, write-out the goals you came up with, and take care of any annual minutes and formal documents that should be completed for your entity.  Scribbling on a bar napkin will not cut it; in fact, the more documentation the better in this case as you need to prove substantial business reasons for the trip.
  • If your spouse joins you on the trip, his or her expenses are generally only deductible if they are an officer, shareholder, member, director, or employee of the business – or if there is a bona fide business purpose for them to be on the trip.
  • If it is a foreign trip, more detailed rules apply.  If the trip is seven days or less in length and primarily for business, then the travel is fully deductible.  However, if the trip is over seven days, the travel expense deduction is restricted if 25% or more of the days are not business days.  It becomes complicated as you can take advantage of “intervening days”, so you should definitely talk to your CPA or accountant first.

There are other considerations and the facts and circumstances of each trip need to be considered.  There is no clear rule on the number of personal days allowable before it becomes primarily a personal trip.  Also, bringing children on the trip can further complicate the issue as it can make it look much more like a personal vacation.  If anything – just make sure you document, document, and document some more, and again – I strongly suggest talking to your CPA or accountant before setting up a business planning trip that you intend to claim a business travel expense.

There is only a little over a month left of summer – get out there and do some business planning! 🙂

Oregon Business Tax Increase Update

As many of you may already know, there was a bit of drama last Wednesday in the Oregon Senate when House Bill 3405, which increases taxes on corporations and businesses in Oregon, was derailed by just one vote.  However, Thursday the vote changed and bill passed the Senate,  and now it is on its way to Governor Kulongoski, who has already made a statement about it leaving no doubt that we need to start preparing the changes.

All businesses in Oregon or doing business in Oregon are affected by this change – whether you have a C-Corporation, S-Corporation, LLC, LLP, or partnership, you will be paying more for Oregon excise tax, filing fees, and annual registration fees.  Here is what you will need to know:


Increased Minimum Excise Tax

The low $10 minimum tax for filing business entities (not including disregarded entities) has been increased to $150 for tax years beginning on or after January 1, 2009.  For C-Corporations, the minimum tax of $150 only applies to corporations with Oregon sales less than $500k.  C-Corporation with Oregon sales over $500k will now pay a minimum tax based on a multi-tiered calculation based on the level of sales.


C-Corporation Minimum Excise Tax Increase

Oregon minimum excise tax for C-Corporations can now range from $150 all the way up to $100k depending on the level of Oregon sales.  For a complete breakdown of the tax based on Oregon sales tiers, see page 2 of HB3405.  Here is a quick summary of the minimum tax amounts for smaller businesses:

  • Oregon sales over $500k but under $1 million = $500 tax
  • From $1 million to 2 million = $1,000 tax
  • From $2 million to 3 million = $1,500 tax
  • From $3 million to 5 million = $2,000 tax

In addition, the tax rate for C-Corporations increases from 6.6% (current rate) to 7.9% for taxable income in excess of $250k.


Filing Fee Increases

In addition to tax increases, HB3405 will double most business registration filing fees with the Oregon Secretary of State from $50 to $100.  Some filing fees, like those for authority to transact business in the state,  will increase to $275.


Increased Document Fees

Most copy and certificate fees will also increase at the Secretary of State’s office.  In addition, the notary public fees will increase from $20 to $40.

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All in all, the increases are not a surprise for most of us.  The Oregon excise tax has been much lower than similar taxes in most states, and there was talk before the recession about increasing the tax to $50.  However, for the small business owner in Portland, this is not the best news – especially after the Multnomah County minimum tax increase for 2008.

For those of you with C-Corporations, you may want to talk with your CPA regarding the cost to convert to an S-Corporation.  For many, the large amount of built-in gains tax would not make the conversion worthwhile, but with this tax increase and the likely upcoming expiration of qualified dividends and low capital gains rates, it is definitely worth looking into as some could see long-term tax savings.

Loans from S-Corporation Shareholders

1120s

If you were to loan me $20k today, would you insist on loan documents, regular payments, and interest?  Of course you would!  Such requirements and documentation would seem to be common sense, so why do many shareholders fail treat the loans to their S-Corporations the same way?

An S-Corporation is a separate legal entity, and any transactions between shareholder and the corporation have to be treated as such.  Any funds contributed by the shareholder are either capital contributions or loans from the shareholder.  If the corporation pays personal expenses for the convenience of the shareholder, the payment has to be reclassified as a loan from shareholder repayment or a distribution.  There needs to be a very clear distinction between shareholder and corporation with these transactions and the documentation should be the same as if the transactions were with an unrelated third-party.

In my experience, I have seen this issue come up in IRS audits and with bank loan renewals and applications – especially with S-Corporations owned by a single shareholder.  Without other shareholders to help keep things formal and a clear separation between business expenses and shareholder personal expenses, the single shareholder can get lazy and end up using their S-Corporation like a personal checking account.  If matched with very poor documentation, this can lead to big problems with the IRS – even loss of the S-election status in serious cases.

How can you avoid these problems and make sure you are properly documenting your shareholder loans?  Here are my suggestions based on my experiences with small S-Corporations:

  • Keep your personal expenditures and transactions out of the S-Corporation.  It is a separate legal entity and there is no reason for co-mingling personal and business transactions except for the occasional payment for the convenience of the shareholder.
  • Reimburse any expenses paid personally on a regular basis via an signed expense report.  Attach receipts and document the who, where, what, and why for meals and entertainment, travel, and other expenses that need explanation as to the business purpose.
  • Avoid using personal credit cards for the business; however, if you must resort to this, try to use the card(s) exclusively for business and then use other personal credit cards for personal transactions.
  • If you loan funds to the S-Corporation, keep a record of the loan and try to have the corporation make regularly scheduled repayments.  If the loan exceeds $10k, the corporation needs to start tracking and paying interest on the loan principal.
  • Talk with your CPA and make sure you understand any reclassification entries made to loans from shareholder accounts.
  • Use a lawyer that specializes in small business that will prepare demand notes and documentation for the loan from shareholder on a regular basis.  Many small S-Corporations try to cut corners in this area and it can really hurt them down the line.
  • Document, document, document!  I know life is busy and small businesses require more time than you have, but do not get behind on this or create excuses for yourself.  If you cannot meet documentation requirements, then you should not be incorporated.

LLC vs. S-Corporation, Round 1

When setting up a business and deciding on entity type, most people are looking for 1) liability protection and 2) tax savings – specifically lowering self-employment tax liability.  For small businesses, the two best options are the LLC or the S-Corporation, and many tax or legal professionals seem to advocate for one team or the other so it is hard to know what entity is truly best for your business.  Well, I am not your advisor and I have been on both teams, so hopefully I can provide you with some balanced information and after a couple rounds, hopefully we will have a winner for your business…

Will the business own appreciating property like real estate?

If your business has anything to do with real estate rentals or owning and managing commercial or residential property, then LLC is the early winner.  This is vitally important – you should never put real estate into a corporation.  If a CPA or tax practitioner recommends this for a new small business, I would consider it malpractice.

Basically, if you put real property into an S-Corporation, then you are going to have a taxable event if you transfer it out of the corporation in the future and you will pay tax based on the fair market value of the property at that time.  I could tell you some horror stories on this issue, but trust me – if you have a residential or commercial property, put it in an LLC.
LLCs are perfect for real estate as you can move the property in and out of the entity without any taxable events.  Plus, they are much easier to setup, administer, and report for tax purposes.  Even better, if you have one owner, you can use the single-member LLC for your real estate and then the tax reporting is simplified so that you only have to complete a Schedule E as part of your personal return.

How many owners will the business have?

This is another important question to look at upfront, as it can result in a knock out in round one.  If you will be the sole owner of the business, then your options are limited to the following:

Single-member LLC (SMLLC)

The only LLC offering for the single-owner business is a great option for easy setup, administration, and tax reporting; however, it is going to cost you in the form of self-employment tax.  To the IRS, The SMLLC is no different than a sole proprietorship – in fact, the SMLLC is reported on Schedule C just like a sole proprietorship.  Unfortunately, this means that you will pay self-employment tax (15.4%) on the entire amount of your net taxable earnings.  This can really add up – especially if you are a consultant with few expenses and/or minimal capital asset needs.  After a few years of paying a hefty tax bill, most business owners are willing to put up with some extra administration and tax prep costs in exchange for a much lower tax bill via use of the S-Corporation while paying themselves a reasonable wage.

S-Corporation

The big winner for single-owner businesses is clearly the S-Corporation as most business owners can end up saving thousands.  With an S-Corporation, you do not pay self-employment tax on the earnings, BUT the owner must pay himself a “reasonable” salary, which means you are paying payroll taxes on the Federal and state level.  Usually, if you sit down with a CPA and lay this all out, they should be able to give you a ballpark of your tax savings each year; however, there are costs related with this:

  • Legal costs – it is not cheap to setup, but I would never suggest a D.I.Y for an S-Corporation.  Get it setup right and avoid legal problems later.
  • Accounting Fees – keeping your accounting data on a spreadsheet may not cut it anymore – especially if you use a lot of credit cards and loans.  Be prepared to pay a bookkeeper or an accountant to get your books setup right so that the tax preparation goes smoothly.
  • Tax Prep fees – S-Corporation returns require much more work and typically range from $750 – $2000 or higher depending on complication.  Plus, you now have to file quarterly payroll tax returns and payroll to process, which can run you about $95/quarter even with one employee using ADP, Paychex, of your CPA.

If your savings are still substantial after factoring in these costs, then you should definitely go with the S-Corporation, but make sure you have a good lawyer and a good CPA that you like as you will be talking to them frequently for the first few years.

Well, round 1 is in the bag and we are tied at 1 a piece.  In round 2 we will deal with issues for businesses with more than owner.

Just remember – never choose an entity for your business without consulting a CPA and lawyer as every situation and business is unique.  Give me a call at 503.224.8844 if you need a CPA or a lawyer to help you with your new business.

Tax Return Adjusting Entries

When you get your corporate, LLC, partnership, or other business tax return from your CPA or tax preparer, do they give you adjusting entries to import or manually input into your accounting system?  Do they review your QuickBooks file and advise you on how to record the transactions in a more effective manner?

Adjusting journal entries are so crucial to the success of your accounting system, and often many CPAs and tax preparers get so busy that they never get around to this important aspect of their preparation services.  If you do not receive adjusting journal entries, make sure you ask your tax preparer for them today.  These entries will correct any errors, make important reclassifications of transactions, record depreciation, and match your books to the tax return.

In some cases, if your QuickBooks file and/or accounting records are really poor, your accountant may suggest starting a new file rather than providing journal entries, but most of the time your tax preparer should be able to provide this service without much additional work.  In addition, you should ask for depreciation entries for the current year, and amortization schedules for any loans.

Make sure you are getting more than just a tax return from your CPA or tax preparer as any tax preparer can give you that.  You should expect your preparer to come alongside you aside you and advise and equip you so that you can be more successful, maximize your tax savings, and make solid financial decisions for your business.

If you are looking for or considering a new CPA, give me a call at 503.244.8844 or email at brian@PandGCPA.com as I would love to hear from you and discuss our firm’s services.

City of Portland Tax Extension Reminder

We are at the 11th hour for filing tax returns today – hopefully you have filed already or have sent in an extension.

Just a quick, last-minute reminder for those of you who have not yet filed the 2008 return for your corporation, LLC, partnership, or sole proprietorship business and do business in the City of Portland and/or Multnomah County – remember to extend your City of Portland return.

Unfortunately, many forget this return and end up with some sizable penalties when they finally file.  However, the City has made the process much easier than prior years as payment is no longer required, so you have no excuse this year.

File Online – quick and painless, credit card payment option

Download the Fillable Pdf – for those of you who want to wait at the post office.

Happy Tax Day!