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.

Deducting Convention Travel Expenses

This is a quick tax tip inspired by a unique structure in the Portland skyline, which is currently getting pounded with torrential rain.

If you can show that your attendance at a convention benefits your business, you can deduct your travel expenses.  This requirement applies even if you are appointed or elected as a delegate of an organization.

  • Make sure you keep the agenda or program materials from the convention, as these documents are the best evidence to show that the convention is connected to your business.
  • Avoid conventions that are for investment, political, social, or other purposes unrelated to your business, as you cannot deduct expenses for these events.
  • Finally, you might want to think twice about a foreign convention, as the IRS has a four-point reasonableness test to judge deductions for conventions outside the North American area.  Be prepared to provide a lot of detail on the purpose of the event and activities, the sponsoring organization and the residences of active members in the organization in order to prove that the convention location was reasonable.

Lastly, if you receive a shiny brochure trying to sell you on a convention or seminar on a cruise ship, just throw it away.  Cruise ship deductions are limited to $2,000 per year and the IRS has a long list of rules that disqualify many of the good cruises.  Plus, you have to attach two signed documents to your tax return.  Trust me, stick to conventions on dry land and take the cruise for your personal vacation – any tax savings are just not worth the hassle.

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.

1099 Requirements & Increased IRS Penalties

The Small Business Jobs Act of 2010 has substantially increased the penalties for failing to timely file 1099 information returns for payments made in 2010.  If you intentionally disregard sending these forms to vendors and the IRS, the penalty can be $500 per form.  If you make an attempt by sending 1099’s and you miss some, the penalty goes down to $200 per form.   Therefore, we strongly urge you to go through your vendor list and issue 1099s to the following types of vendors:

1.       Vendors who provide you business professional services such as but not limited to accounting, bookkeeping, janitorial, IT consulting and who are not incorporated.  Vendors in this category will include most businesses who are LLCs and LLPs as most of these entities are taxed as partnerships.
2.       All payments to attorneys both incorporated and those not incorporated.

The due date for providing the payee Form 1099 is January 31, 2011.
The due date for providing the IRS Form 1099 is February 28, 2011.

Here is the link to the IRS From W-9 , Request for Taxpayer Identification Number and Certification, to aid you in gathering the required information from your vendors.

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.

2010 Standard Mileage Rates

Usually I post the new mileage rates as soon as the IRS the comes down from the mountain with the latest tablets; however, this year it was not all that exciting as we have a decrease as compared to prior years.  Here they are:

Beginning on Jan. 1, 2010, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:

  • 50 cents per mile for business miles driven
  • 16.5 cents per mile driven for medical or moving purposes
  • 14 cents per mile driven in service of charitable organizations

Source: IRS – IR-2009-111, Dec. 3, 2009

Remember, you need to keep a contemporaneous record or log of your mileage.  If you tech saavy, there are several apps for that (like Milebug), which will (hopefully) make it easier for you.

Also, even if you are depreciating your business vehicle, you need to keep a log to prove the percentage of business usage you are using.  This is not as much an issue with large specialty vans & trucks, but with passenger vehicles it is very important.

Finally, make sure you understand the rules on a qualifying home office and commuting miles so that you can maximize your business miles.

New Tax Q&A Website – TaxQueries.com

While I realize I have not posted any new articles lately, there have been some great questions on this site lately and I have enjoyed answering them as they have inspired some ideas for future posts.  Thank you for the great questions!  I would definitely encourage you keeping posting any questions you may have on the posts on this site.

In addition, I would like to refer you to a great new tax question and answer site: TaxQueries.com.  They just opened and already have some good content.  The design uses OpenID, which is great because you can easily use any of your profiles from other OpenID sites without having to setup an account like with other sites.

It is definitely worth checking out as it should become a good resource for business owners, tax professionals, and anyone else who is looking for answers to their tax questions.

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.

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.