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As a business owner or taxpayer, you must understand general rules in order for you to minimize the taxes you owe. Below is a list of "hot topics" explained in "English," that will provide you with valuable need-to-know information.
Does your main/only income come from a job where you receive a W-2? If so, this probably doesn't apply to you. However, if you receive any investment, flow-through (from K-1s), or other type of income, you could be subject to large penalties and interest on April 15th if you don't make tax payments as you earn the income!
The Home Office Deduction... To Take or Not to Take?
Has your friend, neighbor or colleague told you that if you take the home office deduction, it will be a “red flag” to the IRS that will trigger an audit? Well, that is just not true!
In order to claim the home office deduction, you MUST QUALIFY. To qualify, you are required to meet 2 tests: regularly used and exclusively used for business.
Regular Use: this test is clear – you use the area on a continuing basis. Occasional or incidental business use does not meet the test.
Exclusive Use: a specific part of a taxpayer’s home is used for business only. There is no requirement that the business portion of a room be physically separated by a wall or partition. But, any personal use of the space, no matter how small, means that it is not exclusive. There are two exceptions: storage space and daycare facility.
You can have several offices. The key issue is to determine your PRINCIPAL PLACE OF BUSINESS.
Your home can qualify as a principal place of business if:
A business use of the home deduction is allowed if the taxpayer meets clients in their home. For example, if an attorney works 4 days a week in his downtown office and 1 day at his home office, he can deduct the home office if he meets with his clients there too. It will qualify for the deduction even though it is not the principal place of business.
The best thing about qualifying your home as the principal place of business is that the miles that you drive from your home to the first business stop is now deductible. If your home is not the principal place of business, your first stop is considered commuting and not deductible.
The easiest way to determine the business percentage is to take the total square footage exclusively and regularly used for business and divide that by the total square footage of your home. Then, you can deduct the following categories on your return for the business percentage
Note: Lawn care/landscaping expenses are not deductible according to the IRS regulations. However, the Tax Court allowed the deduction where the taxpayer’s clients regularly visited the taxpayer’s home office and where the taxpayer was a daycare provider and the children used the lawn as a play area.
If you painted the office area only, that cost would be 100% deductible. This is called direct expenses. However, if you paid for garbage for the home, only the business percentage used is deductible which is called indirect expenses.
If your total income is less than your total expenses, your home office deduction for certain expenses will be limited. However, these deductions can carry over the next year. Be aware of that carry over number if this happens in your situation.
If you take depreciation on your home office and you sell your home, you have to “recapture that amount”. What this means is that the amount you deducted for depreciation reduces your ordinary income – this is good. But when you sell your home, that amount will increase your capital gains. The capital gains rate is typically less than your personal income tax bracket.
Years ago, many tax preparers would never take the home office on an LLC, S-corp or C-corp return. If they did, it would be a Schedule A deduction as an employee, which is not a great deduction due to the 2% limitations. However, now some preparers are taking the home office for these entities. The only thing I recommend is not to take mortgage interest or real estate taxes. Only take the business portion of rent, utilities and insurance.
When you know the rules, there should be no fear around taking a deduction that you qualify for. So…do you qualify? If so, take the deduction, reduce your taxes and don’t worry about that “red flag” because if audited, there will be no change on your return because you know the rules!
Consult your tax preparer to confirm your specific situation qualifies!
Auto Rules You Need to Know!
Probably one of the most frequently asked questions I receive revolves around auto use for business: What can I deduct?; Lease or buy?; What miles count?, etc. Here are some general rules you need to know to make sure you get every deduction allowed on your auto use!
First, you need to understand that the IRS allows you to take the higher of two amounts when it comes to your auto. You can deduct the business miles driven at the IRS rate for that year OR you can deduct actual costs; such as, gas, repairs, insurance and the amount allowed for depreciation. What most business owners miss is the percentage of business use. Usually the percentage is less than 100%. Each owner needs to determine the business percentage for the year.
You also need to know that a mileage log is required in order to get the deduction. This includes the date, starting odometer reading, ending odometer reading and business purpose. You are allowed to recreate the log using your calendar and receipts. One simple thing you can do that takes 2 minutes is to write down your odometer reading each year on December 31st. This number gives you a starting point knowing how many miles you drove each year.
One of the top mistakes business owners make is tracking miles driven from their home to work. These miles are called commuting miles which you must qualify for in order to deduct them. How do you qualify? You can only count those miles IF you have a home office and qualify for a home office. If you don’t have a home office, those first miles to work are NOT deductible.
Do you ever wonder if it is better to lease a vehicle or buy? Tax-wise, it does not matter. You are going to get a deduction for the amount you paid based upon the business percentage of use. What you should be asking is what the better financial choice is. In my opinion, buying is better than leasing. You might not like my next recommendation, but I feel that it is better to buy used than new. I know, I too like the “new car smell”, but you can pay thousands less for a reliable used car than a new car. Just my two cents.
I have had someone tell me that they want to deduct their auto 100% because they have a business sign on the vehicle. They said they see this as advertising. Sorry…the IRS’ rules don’t agree. You can deduct the cost of the signs, but the auto rules are the same – based on the percentage of business miles.
Know the auto rules so you know what is expected of you! This will get you every deduction allowed!
When You Give a Gift to Charity…Chances are…
Did you know that you may be able to reduce your taxable income by donating cash or goods to a “qualified charity”? Giving your neighbor or family member money to help them cover bills in a challenging economy does not qualify. But any amount you give to a “qualified” organization does!
Some examples of qualified organizations include:
Donating from business accounts
When you give from your business, the donation is handled differently based upon the entity.
Here are some examples of how the gift is deducted:
Donating in which you received something in return
When you give money and get something in return, the value of what you received is NOT deductible. For example, have you given money to participate in a golf tournament that raises money for a charity? If so, only a portion of the fee is deductible. Have you attended a charity dinner to donate money for an important issue? If so, only a portion of the money you gave is deductible, and it does not include the cost of the dinner. Have you given money to an organization - like the Monterey Bay Aquarium - and received admission tickets as a thank you? If so, only a portion of your gift is deductible.
Limitations on gifts
Generally, you can give up to 50% of your earned income (30% for some items). If you give more than that, any non-deductible gifts will carry forward to the next year. This carryover is good until used or as many as five years, but not beyond that time.
Some examples of gifts that are NOT deductible:
*Look for our July 3rd newsletter to read about the rules with specific TYPES of donations; for example, cash, non-cash, charitable miles driven, etc.
Did you know that you may be able to reduce your taxable income by donating cash or goods?
You must show proof regardless of the amount for any cash donations you give. This proof can be a cancelled check, bank or credit card statement. Gifts of $5 in an offering basket at church are not deductible unless the organization reports the donation. When you give a gift of $250 or more, you are required to get a receipt from the charity showing the amount and date of contribution. No receipt = no deduction.
Non-Cash or Tangible Donations
Examples of non-cash donations include household items, furniture, appliances, electronics, stocks, etc. Food, paintings, jewelry, or antiques do not qualify.
One of the biggest changes in the non-cash area of contributions is that the IRS noticed that taxpayers were dumping off their “junk” and taking a donation for it. The IRS says that the items you give away MUST be in “good condition” or better. And, you are required to have proof of the donation with a receipt. Some taxpayers will take photos of their items before they drop them off to the charity.
If your total non-cash donations exceed $500, you are required to file an additional tax form 8283 stating the date, items donated, charity name, address and value of the donation.
Charitable miles driven
Do you use your vehicle for charity purposes? Did you know you can deduct 14 cents per mile for any charitable miles driven?
Donating your time
People often ask, “How much can I deduct for donating my time to charity?” One person might value their time at $50 per hour, another at $150 and another at $250. An attorney donated his time to sit on a charitable board of directors. He valued his time at $19,000 of billable time spent. However, it might surprise you that the IRS does NOT allow any deduction for your time.
Donating a Vehicle
In years past, the value of a vehicle that you donated to charity would be entered on your tax return. That rule changed a few years back. Now, the charity sends you a notice stating the amount they sold it for, which you may take as a deduction.
You can read more details from IRS’ publication 526 at:
Household Employee Rules
Do you pay a housekeeper, babysitter or gardener? Many people pay someone to help them around the house, but they don’t realize that in doing so, they may be signing up to pay additional taxes.
Innocently, you may pay for a house keeper, gardener or a nanny, but are you aware that you may need to pay payroll taxes on the work they are doing? Here are the rules when it comes to hiring people to help you in your home.
Common types of work that you may hire someone to help you with include cleaning the house, lawn work or even watching your kids. If you hire someone who has a business (self-employed), you may need to issue them a 1099-MISC for any amounts you pay over $600. If it is an incorporated company, no 1099 is required. However, if you pay an individual who does NOT have a business, you are required to pay Medicare and Social Security taxes on any amount over $1,800 for 2012.
When you hire someone to work on a regular basis, you need to fill out Form I-9, showing that the person is eligible to work in the US. This form is available from the Department of Homeland Security at http://www.uscis.gov/files/form/i-9.pdf. Do not send this form to the IRS, but make sure to keep it on file. It is unlawful for you to knowingly hire or continue to employ a person who cannot legally work in the United States.
Federal withholding is not required unless your employee requests it. However, if you do withhold, you will need to get an EIN (employer identification number) so all tax forms and payments can be tracked correctly. You will also need to issue the individual a W-2 form. Also required is a Schedule H form reporting the household employee activity that needs to be filed with your personal tax return.
So be aware of the rules for paying someone for household help. It is common that people do not report this activity correctly since many do not know about the rules. Now that you have a general understanding, contact your accountant to confirm if your specific situation requires a Schedule H form to be filed.
You can read more details from the IRS’ publication 926:
Is Your Business Considered a Hobby by the IRS?
Very frequently I get people asking me clarification on IRS rules that they heard from a friend, neighbor or colleague. Usually some part of the statement is true, but there is always more to the story or it may not apply to that person’s specific situation. How many of you heard the statement, “You can’t deduct a loss from business if it is more than 3 out of 5 years.”? Well, this is not the entire truth.
A person that conducts an activity for profit is allowed to deduct the expenses that are ordinary and necessary in that industry. If the expenses exceed the income, the amount can offset other income such as wages, interest or dividends. However, if your activity is a hobby, you cannot reduce your other income by the losses.
When your losses exceed the 3 year rule, the burden of proof now shifts to the taxpayer to prove the activity is a for-profit business.
Here are some factors to consider:
Here are some ways to ensure your for-profit business is not considered as a hobby:
I had a client that had a business of being a personal chef. This was not his primary way of earning income. He had a W-2 job with a local city. He did earn about $200-300 in income; however, his expenses were much more than that. Come to find out, he was hosting dinner parties at his home and wanting to write off the food, subscription to cooking magazines and seeds for his home garden.
If you are in doubt, just imagine yourself in front of an auditor explaining your specific situation. If it “feels” like the story above, it may not fly with the auditor, but that does not mean it is not a true business. What you need to do is plan and strategize. What can you do today to prove that you are a for-profit business?
Know the rules and then step out in confidence. And, don’t get tax advice from a friend because it might not be the whole truth! Consult your tax preparer to confirm your specific situation qualifies!
High Income Wages:
How & Why the Amount Will Affect Your Tax Return!
More and more taxpayers are having deductions and credits either limited or completely disallowed because of the level of their adjusted gross income (AGI). AGI is your income minus qualified deductions, i.e. alimony, student loan interest. Check the list below to see if you might fall into any of these limitations.
Child Tax Credit – This credit is generally $1,000 per child 16 and younger. However, the amount of the credit decreases as your income rises. For single and head of household taxpayers, the credit begins to decrease at $75,000 Adjusted Gross Income (AGI). It decreases at $110,000 AGI for married filers.
AMT – To prevent higher-income taxpayers from claiming so many deductions, Congress created the Alternative Minimum Tax (AMT) in 1969. AMT is not adjusted for inflation, so a growing number of middle-income taxpayers are discovering they have to pay it.
You may have to pay the AMT if your taxable income, plus any adjustments and special items that may apply to you, are more than the AMT exemption amount.
For 2011, taxpayers get the following amounts as exemptions from AMT:
IRA Contributions – Both Roth and traditional IRA contribution benefits are limited based on AGI. For Roth IRA’s, single taxpayers with an AGI over $107,000 begin to see their contribution limit drop until at $122,000, it goes away completely. The limits for Married Filing Jointly investors are $169,000-$179,000. For Traditional IRAs, single taxpayers with an AGI over $56,000 begin to see their contribution limit drop until at $66,000 it goes away completely. The limits for married filing jointly investors are $90,000-$110,000.
SINGLE $107,000 - $122,000 $56,000 - $66,000
FILING JOINTLY $169,000 - $179,000 $90,000 - $110,000
Medical Deductions – Taxpayers cannot begin to deduct medical expenses until they exceed 7.5 percent of AGI. That means the higher your income, the less likely you will be to qualify to deduct any of these expenses unless you have very high medical costs. For example, if you make $100,000 a year and paid $7,501 in medical expenses, you would be able to deduct only $1.
Education Credits – Education credits include the American Opportunity Credit, which covers up to $2,500 of undergraduate costs, and the Lifetime Learning Credit, which covers up to $2,000 of undergraduate and graduate school costs.
For the American Opportunity Credit, the credit begins to phase out at $80,000 to $90,000 for single filers or $160,000 to $180,000 for married couples filing jointly.
For the Lifetime Learning Credit, the range at which the credit begins to decrease is $50,000 to $60,000 for single filers and $100,000 to $120,000 for married couples filing jointly. Taxpayers are not eligible for either credit if married filing separately. When parents have a high AGI, it’s sometimes better for children to claim themselves. Consult your tax preparer to crunch the numbers.
SINGLE $80,000 - $90,000 $50,000 - $60,000
FILING JOINTLY $160,000 - $180,000 $100,000 - $120,000
2% Floor Deductions – Taxpayers cannot begin to deduct miscellaneous expenses until they exceed 2 percent of their AGI. For example, if you make $100,000 a year and had $2,500 in miscellaneous expenses, you would be able to deduct $500. Deductions subject to the 2 percent limit include unreimbursed employee expenses, tax preparation fees, and many “other” expenses as defined by the IRS in Publication 529 which can be viewed at:
Rental Losses – Owning a rental property is a great investment, but it might not have all the advantages you are hoping for if your AGI is more than $100,000. If your rental has a loss, the deduction is reduced as your AGI rises above $100,000. If your AGI is more than $150,000, your loss is totally suspended and you get no tax benefits that year. However, unused losses will be carried forward to future years and used when a profit or sale of property occurs.
Mortgage Interest – Only interest on the first $1.1 million of debt to purchase a house is deductible. Any interest above this amount is not tax deductible. This amount includes home equity loans up to $100,000.
1099's: How to Avoid an Audit
Processing 1099’s can be confusing and frustrating. Admin Books enjoys passing on important information that will help you find your way through the requirements of 1099’s. Here are some facts you need to know!
General Rule: If you pay someone more than $600 in a calendar year for services, not material/product, then you are required to provide a 1099 showing the amount you paid. One tip is to collect a W-9 at the time of payment so you know if the business is a sole proprietorship, LLC or Corporation. If it is a corporation, then no 1099 is required. The 1099 is due January 31st and the required 1096 is due February 28th.
Addressing the 1099: If the person you paid uses their Social Security number as a tax ID number (which I don’t recommend), then the person’s full name must be on the first line of the 1099. If you list the business name by mistake, then you will receive a letter from the IRS saying that the name and ID do not match. Then the IRS may require you to withhold money from future checks.
Reimbursed Expenses: If you pay a subcontractor for expenses incurred, do NOT include that amount in box 7. If you receive a 1099 from someone with reimbursed expenses, like travel or postage, don’t worry. Show the full amount of income on your tax return and then show the full amount of expenses and it will net out the same. If you lower the 1099 amount on your return to “correct” it, that will trigger an audit.
Strict Classification Rules: If you hire a subcontractor, be sure that the state won’t deem the person as an employee. A few indications to strengthen your case are:
New 1099-K Rules:
There has been a lot of confusion regarding the new 1099-K rules. All merchant companies that process credit card payments are required to issue 1099-K’s to the seller. It can be for 1 transaction for any amount. The main reason for this new law is to capture payments going through eBay, PayPal and Amazon. However, now the common business owner will get a 1099-K as well if their clients/customers pay them with a credit card. Here is the confusing part: businesses will provide a 1099-MISC for payments made with a check/cash and the merchant company will process 1099-K’s made with a credit card. Let’s give some examples to clarify:
Example 1 – You pay a subcontractor $700 for services. If you paid them with a check, you issue them a 1099-MISC.
Example 2 – You pay a subcontractor $700 with a check and $800 with a credit card. You will issue them a 1099-MISC for $700 and the subcontractor’s merchant company will give them a 1099-K for the $800.
Example 3 – You pay a subcontractor $300 with a check and $800 with a credit card. We recommend that you still issue a 1099-MISC for $300 because the combine total payment to the subcontractor (check and credit card) was over the $600 amount – this is the safe answer.
Oddball Clarifications: If the contractor is NOT a US citizen and lives in another country, have them fill out a W-8 and keep this on file. Prepare a 1099, but there will be no tax ID number on the form. If questioned by the IRS, show them a copy of the W-8.
If the 1099 comes back to you undelivered, keep a copy for your records to show the attempt.
If the contractor has already performed their services and you cannot get the contractor to fill out the W-9, keep a log of the attempts to contact them by phone, email or letter. The IRS has penalties for not sending the 1099 and if you show intent, hopefully there will be grace in the penalties.
If you find you made a mistake on the amount or tax ID number, you can always correct the form and re-send it by checking the “Corrected” box.
Corporations do NOT get 1099’s, but some people are confused if they should send a 1099 to LLC’s. Send a 1099 to single-member LLC’s and multi-member LLC’s (partnerships.)
1099’s are required to ALL attorneys regardless of their entity!
If you have any clarifications, please contact our office. If you would like to delegate this project, we would be honored to help.
Call our office at 408-782-9640 for 1099 pricing.
Entertainment Deductions - Half the Fun?
Basic Rules: Here are some basic rules you need to know to ensure that all your entertainment expenses are deductible:
Reasonable, Lavish, and Extravagant:
So does the entertainment need to be reasonable? Can you get in trouble if the entertainment is lavish and extravagant? Actually, no. The only rule is that it is must be an ordinary and necessary expense. There are no parameters on how much you can or cannot spend. In fact, a self-employed business person spent over $60,000 on entertainment (rock concerts). His entertainment expense was disallowed – not because of the amount – but because he did not have documentation to support the deduction.
The IRS looks at how much business was generated as a result of the entertainment. There is no rule regarding the number of times you may entertain a potential client, but a wise business person would limit the frequency within reason. But then again, what is reasonable? Taking your spouse out on a date once a month would not qualify. However, you could consider taking your mother out if she is a potential client/customer who will buy services or products from you – nothing wrong with that!
50% vs. 100% Deductible: Almost all entertainment is deductible at 50%, meaning that if you spend $500, you receive only a $250 deduction. Here’s the good news – any entertainment that revolves around a sporting event is deductible 100%; that includes any ticket or sports event, only if:
So a PGA tour event would be 100% deductible because they donate the net proceeds to charity, but a ticket to a college or high school sports event does not qualify since that usually goes toward the coaches’ pay. Other events that may qualify for a 100% deductible are tennis, skeet shoots, ski tournaments and fishing tournaments, just to name a few.
Another thing to keep in mind is that generally, you will get a better deduction if you list an expense to a sporting event as a business deduction rather than a charitable donation. For the contribution to a charity, you can deduct only the amount that exceeds the benefit you received from the item (the value of the entertainment).
Additional 100% deductible entertainment expenses are employee holiday parties, annual picnics or summer outings. For example, a service corporation rented a powerboat and was able to deduct 100% of the $41,000 expense since it did not discriminate between the owners and employees and it was deemed ordinary and necessary.
*Note: Create two accounts in your books – one for 50% and the other for 100% deducible entertainment.
Be strategic: Plan a business meeting for a substantial amount of time (say two hours) and then go skiing. You cannot deduct your personal skiing with your family (unless your spouse is active in the business), but you can deduct the entertainment with people who you plan to do business with. After skiing, resume your meeting for another two hours and one minute.
Failure to File and Failure to Pay:
Are you Headed for T-R-O-U-B-L-E?
The old saying goes, “There are only two certainties in life: death and taxes.” Have you ever wondered what would happen if you filed your tax return late or worse, did not file at all? Well, you are looking for trouble if you do not file your tax return.
If you do not file an income tax return, the IRS will gather all the transmitted tax documents and create a “substitute return” for you. If they show you are due a refund, nothing further will be done. Surprised? If they show you owe money, they will begin sending you collection letters.
And, if that is not bad enough, there will be a penalty for not filing your return equaling 5% per month up to 25% of the tax due. Then, there is another penalty of .5% per month up to 25% of the tax due for failure to pay the tax. An example is if you owe $1000, it will cost you $250 penalty for not filing, but only a $5 penalty for not paying. And then, don’t forget they tack on interest to that number!
If you qualify for a refund and wait more than 3 years to file your return, the IRS will take that refund money away from you because the statute of limitations expires. Don’t expect them to send you a reminder letter!
In addition to the penalties you are charged for not filing your return, you also increase your chances of being audited. For example, if you file on time, you have a 3% chance of an audit. If you don’t file on time, your chance of being audited increases to 50%! Yikes!
There have been many high profile cases about celebrities not filing or paying their taxes.
Here is a list of people that owe or have owed the IRS:
The general rule is to file on time (okay to file up to the extension deadline) since the consequences are more harsh for not filing than not paying the tax due.
Don’t put yourself in a position of grief.
Even if you are not ready to file,
file something and you can amend the return later.
The IRS and QuickBooks
Have you heard? IRS auditors are requesting a copy of businesses QuickBooks files to review them. The auditor will recite a fancy IRS code giving their authority to do so. Be smart by following these tips:
Avoid giving the data file by offering to provide information in Excel spreadsheets.
Provide the information they are asking for in this format. If you do not, the IRS can subpoena the data file.
If you do give them a copy of the QuickBooks file and your audit period is for the 2010 year, run “Clean Up of Company Data” where it will archive transactions into journal entries prior to the audit date.
There is no way to delete transactions in one command after the audit date. A suggestion would be to locate a back-up file soon after the ending audit date.
I hope these are some helpful tips, in case you find yourself in this situation. Contact Admin Books if you need assistance and we would be glad to help you through the process.
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