Avoid Fiscal Cliff Panic

As you can imagine, I have heard a lot of panic from clients since the election results came in last month.  Some panic is warranted, as most acknowledge that the 2% payroll tax reduction will not be extended, capital gains will likely be increased to 20% or 25% at most, and that tax rates will likely be increased for married couples with AGI over $250k.  However, when it comes to capital gains, panic can actually be very detrimental and cost you much more in taxes than you would think.

Naturally, you would assume accelerating a large capital gains to take advantage of the 15% rate would result in large tax savings, but unfortunately the alternative minimum tax erodes the tax savings if you are a high-income taxpayer.  In fact, most of the time it results in an overall tax rate between 20% and 25%.  Why this happens is very complex and even CPAs get frustrated in fully understanding the alternative minimum tax, but here is the best explanation I could find.  Basically, if a large amount of your income is long-term capital gain income and you are a high-income taxpayer, the AMT tax can kick in and erase the benefit of the 15% rate.  We witnessed this quite a bit back in 2010 when financial advisers worried about the expiration of the 15% rate and advised their clients to sell off their low basis stock.  It sounded like a great idea at the time, but when preparing the tax returns in 2011, many were surprised at how AMT tax erased much of the benefit.  Well, the same thing can happen for tax year 2012 if you give in to panic.

Before you make any big moves on capital gains before year-end, talk to your CPA and and have them run a projection to see what the true impact would be.  It may just be that there is no need to panic.

Family Employee Payroll Tax Exemption Clarified

The IRS recently issued temporary and proposed regulations that extend tax savings to family-owned businesses that employ their minor children and are organized as single-member limited liability companies.  Essentially, it is nothing more than a clarification on a position that many taxpayers were already taking, but it is worth mentioning, as it is an important tax planning strategy that can produce huge tax savings with the right circumstances.

If you have a business structured as a sole proprietorship or partnership, and you have children that could work in your business, you could be eligible for some big tax savings.  For example, if you paid them up to $5,800 each (the amount of the 2011 standard deduction), they would not be subject to:

  • Federal income taxes on the income,
  • Employee social security tax (4.2% in 2011), or
  • Any Medicare tax (1.45%).

In addition, your business would not have to pay the following taxes:

  • Employer social security tax (6.2%),
  • Employer Medicare tax (1.45%),
  • Federal unemployment tax (.008% on first $7,000 of wages), and
  • Possibly state unemployment tax and other state payroll taxes.

Not only is the payment exempt from almost all employee and employer payroll taxes, it also moves income that would have been taxed at your high marginal tax rate to your children’s rate, which in this case would be zero on the federal side.  Depending on the state, there may be a small amount of state income tax involved, but overall it is going to be very minimal in comparison to the tax that you would have paid at your marginal tax rate.

Better yet, the wages can be used to fund a Roth IRA, a college savings account, or school expenses that would have been paid with or without the payment for wages, so really it is a great benefit that doesn’t necessarily affect cash flow if you plan it out ahead of time.  Lastly, don’t forget the benefit of teaching your children work ethic and getting them involved in your business at a young age.  We work with many fourth-generation family-owned businesses, so this is an important benefit even without the tax exemption.

The Fine Print

What’s the catch?  Well, to make sure the payroll paid to your children will pass IRS scrutiny, the following steps need to be taken:

  • Your child actually has to perform the work,
  • The pay rate needs to be reasonable,
  • Actual paychecks have to be given to your child from the company, and
  • You need to document the work just like you would with any other hourly employee.

As to the type of work, it just needs to be ordinary and necessary for your business and reasonable considering the age of the child.  Have them clean your office or warehouse, file paperwork, or fill in on big projects that you would normally have to hire temporary workers for.  With today’s tech savvy teenagers, you can even have them help out with IT tasks or set up computers and devices.  Whatever you have them do, make sure you treat them just like an unrelated employee if you want to avoid problems with the IRS.

To qualify for exemption from employee and employer social security and Medicare taxes, your child has to be under the age of 18.  The exemption from federal unemployment tax lasts until they reach 21.  There are also many exceptions and details that apply depending on the type of business, and payroll tax reports and W-2s will have to be filed, so it is definitely something that you will need to discuss with your tax professional before starting.

The Recent Clarification by the IRS

Single-member limited liability companies (SMLLCs) are considered disregarded entities for tax purposes and are required to be reported on the member’s 1040 tax return using Schedule C, and up until this point the rules on this payroll tax exemption explicitly included sole proprietorships and partnerships.  The new proposed regulations now specifically include SMLLCs in the list of entities that can take the family employee tax exemption.  This is good news if you have a SMLLC and have been claiming the exemption, and for those that were hesitating because of the wording of the rule.

If you have a corporation, you are not eligible for the exemption; however, in most cases there would still be a tax benefit to paying wages to your children.

If you have a family-owned business in the Portland area and would like to find out more about this tax strategy and others like it, feel free to email or call me at 503.244.8844 to set up an appointment.

2009 Year-End Tax Planning – Part 2

Year-End Tax Planning for Small Business Owners

For 2009, there are plenty of year-end tax planning opportunities available to the small business owner.  Some new provisions help businesses that have been dramatically affected by the recession while others help businesses that have had very a profitable year.  Below is a general overview of several of the more important planning opportunities.

Bonus Depreciation:

Many companies used the bonus depreciation provision in 2008; however, due to the current economic conditions, business owners are much more restrained with regard to capital expenditures than in prior years.  Nick Parsons, one of the partners at our firm, recommends concentrating on capital purchases that are needed and will help generate more profit for the business rather than just purchasing for the sake of tax savings.  He also recommends looking at purchases that will need to be made in the next five to six months and accelerating those purchases if possible before year-end.  Even if the business had a poor year, bonus depreciation could produce a tax loss and actual tax refunds with the new net operating loss carryback rules (see below).

Bonus Depreciation details:

  • Only available for NEW property, 20 year class life or less
  • Provision is scheduled to expire after 2009
  • Must be placed in service before year-end

Code Section 179 Depreciation:

Businesses with net taxable income are taking advantage of the new limits on 179 depreciation ($250k), which allow you to write-off the entire cost of the fixed asset within the year of purchase.  However, many businesses are looking at losses this year, so the bonus depreciation can be a better option.  Regardless, using the right mix of bonus and 179 depreciation can create a net operating loss that can be carried back five years under the new rules (see below).

One minor detail to keep in mind – unlike bonus depreciation, the property does not have to be new to qualify for 179 depreciation.

Vehicle Depreciation:

If a business is looking to buy a new vehicle in the next six months, accelerating the purchase before year-end could be very beneficial.  The luxury auto depreciation limits have been increased from $2,960 to $10,960 through 2009 thanks to bonus depreciation rules.  There are different rules for trucks, vans, and SUVs, but for a typical passenger car used more than 50% in business – this provides great tax savings.

Five Year Carryback of Net Operating Losses:

Many businesses affected by the recession have been able to make use of the expanded net operating loss carryback rules for the 2008 tax year, and many received substantial cash refunds that helped them with current cash flow problems.  Now the carryback rules have been extended for 2009 tax losses, which should bring some more immediate help.  However, the rules are a little more complicated this time around:

  • For 2008, the expanded carryback was only applicable to businesses with gross receipts under $15 million.  The net operating loss could be carried back up to five years and there were no further complications.
  • For 2009, the rule is expanded for all businesses, however, there are complications:
    • For businesses under the $15 million gross receipts limit, the 2009 NOL can be carried back up to 5 years even if the 2008 NOL was carried back under the prior rule.  The only difference is that for 2009, you can only use ½ of the taxable income in the fifth year.
    • For businesses over $15 million in gross receipts, they can use the extended NOL carryback for 2008 OR 2009, but not both years.  Also, like with small businesses, they can only use ½ of the taxable income in the fifth year.

Solo 401k Contributions / Profit – Sharing:

For small business owners that had a good year and are looking for tax deductions while putting away for retirement, the solo 401k is an excellent vehicle that many ignore because of the extra reporting requirements.  Small, family-owned businesses often use the SIMPLE IRA plan to put away up to $11,500 ($14,000 age 50 & older) under the 2009 limits.  However, given sufficient self-employment income, the same small business owner can put away up to $49,000 ($54,500 age 50 & older) using a solo 401k plan and also make the same contribution for the business owner’s spouse if they are involved in the business.  The are special requirements for the solo 401k, so it is definitely something you need to speak with a professional about before opening an account.  However, even if the solo 401k is not an option for you, there are other 401k plans that would still save you much more than with a SIMPLE IRA plan.

2009 Year-End Tax Planning – Part 1

Well, 2009 has flown by and it is time once again to start thinking about year-end tax planning and any opportunities available to lower your tax bill.  Whether you are have a complex business, investments, or just a simple individual tax return; you should take some time before the holidays get too busy to examine how things are looking for the year and look for any planning opportunities.

If you have not read the It’s Only Money column that was in the Sunday Oregonian entitled “Act Now to Save on 2009 Tax Bill”, make sure you check it out.  We had the opportunity to contribute to the small business section of the article, and it has some good information throughout.

There is a lot of ground to cover, but in Part 1 of this post I will concentrate on individual tax planning and opportunities related to your primary residence:

First-Time Home Buyer Credit Extension:

Most people are familiar with the existing first-time home buyer credit that was extended, but the new reduced credit for “long-time homeowners” is a great opportunity as well that some have not looked into.

  • $6,500 credit ($3,250 married filing separately)
  • Have to have owned and used the same principal residence for any 5 consecutive year period during the previous eight-year period ending with the date on which the new residence is purchased.
  • Income phase-outs have been increased and start at $125k for single and $225k for joint returns.  For taxpayers near the phase-out limits, eligibility can be met with some good year-end tax planning.
  • The extended date is 4/30/10; however, it is important that people realize that they just have to enter into a binding contract before 5/1/10 and close by 7/1/10.

I think that this will become popular for those looking to upgrade or downsize – especially after we get passed the holiday season.  However, one note of caution – if you are newly self-employed (within the last year or more), it is extremely to get a mortgage right now.  The new requirement is that you have to have two years of tax returns as a self-employed individual to prove the income.  If you have less than two years of self-employed returns, you may be looking at a serious road block keeping you from taking advantage of the new credit.

Residential Energy Property Credit:

This credit is 30 percent of the sum of expenditures for qualified energy efficiency improvements, including windows, furnaces, water heaters, heat pumps, and more, which are placed in service in 2009 and 2010, which is limited to $1,500 for 2009 and 2010.  The improvements must meet strict energy efficient standards, so taxpayers should do their homework on this one as a mistake could be costly.

Avoid an Unwelcome Surprise:

Lastly, if you are struggling financially due to a loss of a job or reduced income and are behind on mortgage payments and property tax on your primary residence, understand that this could change your 2009 taxes and you could be looking at an unwelcome surprise if you are significantly behind.  For many, interest and property taxes are very significant itemized deductions, so a few month’s worth of unpaid mortgage payments could really increase your tax liability.  It is not something you want to hear if you are in that situation, but it is something to be aware of, and if you can make a payment by the end of the year, it will help your tax situation.

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! 🙂

Year-End Planning for 2008

With a little over a month remaining in 2008, it is important to start year-end planning for tax year 2008 as there are still a number of things you can do to save on taxes and avoid costly mistakes.  

If your income has increased from 2007 or you have some big, one-time gains, it is crucial that you pay 100% of your estimated state tax in the form of a estimates by 12/31/08.  If you have been paying state estimates all year, you will still want to have your CPA estimate your taxable income to see if the 4th quarter estimate needs to be adjusted as estimates are always based on the prior year.  If you are lucky enough to live in Washington or another state without state income tax, you still should watch out-of-state income and keep documentation on sales tax paid on big ticket items.

Why is it so important to pay your 4th quarter state tax estimate by 12/31/08 rather than the 1/15/09 deadline listed on the coupon?

Well, the reason is twofold:

  1. By paying the state tax within the taxable year, you increase your itemized deductions as state income tax is one of the vital itemized deductions if you live in a state with income tax.
     
  2. You also avoid possible alternative minimum tax (AMT) tax consequences in future years by paying your state tax in the taxable year.  If you have significant income in one year and lower income the next year but you fail to make the 4th quarter state estimate until January (or worse – you pay in April or after with your return), then you could end up with AMT tax in that subsequent year with the lower income as state income tax is a preference item for AMT.

 

There is a lot to think about for 2008 tax planning, and I hope to cover many of the different opportunities and tax traps in the next few weeks in upcoming posts.  However, talk to your CPA sooner than later – it will could end up saving you a considerable amount tax and a lot of regret.