Thursday, February 28, 2008

IRS Tax Rebate Checks - Not WHEN, But IF

Unfortunately, the most frequently asked question surrounding the tax rebate checks is "when will I get my rebate check." However, for many, the question should be "am I getting a rebate check?"

Here are a few key bullet points to note regarding the tax rebate checks:

1) As the name implies, they are in fact rebate checks. They are not free money. You must owe tax to receive the rebate. The rebate amounts are not simply $600 or $1,200. They are "the amount of tax you owed up to a maximum of $600 or $1,200" (with a couple of other minor exceptions).

2) You must actually file a tax return in order to qualify. If you typically do not file due to low taxable income or no taxable income, this is the year you need to file a tax return. This holds true for all taxpayers, young and old...from high school and college students all the way up to retirees.

3) Phaseouts start at $75k for a single filer or $150k for a married couple filing a joint return. If you are a single taxpayer earning over $75k or a married couple earning over $150k, you will not receive the full refund. If your income level is high enough, you will not receive a refund at all.

4) Avoid filing extensions for your 2007 tax returns. If you do not file by the April 15th deadline, you will delay the processing of your rebate check since it cannot be calculated until you calculate the amount of tax that is due.


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Seven Essential Tax-Planning Tips for Individual Taxpayers

  • Estimate your alternative minimum tax (AMT) liability. It may be possible to avoid or reduce the AMT by postponing certain “tax preference” items to the following year. Alternatively, you might accelerate income into the current-year if your AMT rate is lower than your regular tax rate.

  • Contribute to your favorite charities. Note, however, that tougher substantiation rules apply to monetary gifts made to charity in the current year. In general, the IRS requires written confirmation of your gift.

  • Bunch medical expenses in the year you may qualify for a deduction. Your unreimbursed expenses can be deducted only to the extent the total exceeds 7.5 percent of your adjusted gross income (AGI).

  • Avoid estimated tax penalties. No penalty is imposed if your tax payments for the current year, including withholding, equal at least 90 percent of this year’s tax liability or 100 percent of last year’s liability (110 percent if your prior year AGI was $150,000 or over).

  • Consolidate personal debts into a home-equity debt. Unlike nondeductible personal loans, you can deduct the interest paid on the first $100,000 of home-equity debt, regardless of how you use the proceeds. Caveat: The debt is secured by your home, so use this technique with discretion.

  • Use capital gains and capital losses to offset each other. Depending on your situation, you may realize gains or losses at year-end. Any excess loss can offset up to $3,000 of ordinary income in the current year.

  • Be mindful of the twenty most commonly overlooked deductions. Forgetting a few smaller deductions may not seem like a big loss, but those omissions add up. Comb your records for deductible business expenses, such as: advertising costs, association dues, bad debts, charity contributions, coffee and food expenses, clothing required for the job, equipment, gifts to clients, home entertainment, insurance, interest on credit cards for business expenses, Internet fees, investment expenses, legal expenses, licensing fees, office supplies, repair costs, subscriptions, theft losses and travel expenses.


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  • Five Essential Tax-Planning Tips for Small Businesses

  • Keep detailed records of collection efforts to support deductions for bad debts that became worthless in 2007.

  • Reschedule business trips planned for early next year to December to increase travel deductions for 2007.

  • Increase your business driving or decrease personal driving—or both—to preserve top-dollar deductions for personally-owned vehicles.

  • If your company operates on the accrual basis, set bonus amounts before January 1, but pay them early next year. Generally, the bonuses aren’t taxable to employees until the year they are paid but can be deducted on your company’s current-year return so long as they’re paid by March 15 of the following year.

  • Nail down current deductions for repairs to business premises by scheduling them separate and apart from major renovations. As opposed to repairs, capital improvements aren’t deductible but are added to the “basis” of property.


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  • Top Three "Don'ts" For Small Business Owners

    Disguise personal expenses as business expenses

  • Claiming 100% deduction for a vehicle that is used for both business and personal purposes

  • Claiming deductions for your spouse’s automobile, cell phone, gas, etc.

  • Claiming deductions for your children’s automobile, cell phone, gas, etc.

  • Pay workers “off the books”

  • Cannot deduct payments to workers if you do not issue corresponding W-2s or 1099s

  • Workers Compensation Insurance carriers are cracking down on ATM Withdrawals, Cash Withdrawals, and checks made payable to cash as the cash is typically used to pay workers “off the books”

  • Claim the Home Office Deduction if you own your home

  • While you may save a few hundred dollars each year you claim the deduction, doing so will not only expose your tax return to a high audit risk, but you may end up paying back thousands in additional taxes when you eventually sell your home

  • If you rent, the deduction is much more advisable…although you will still experience a high audit risk, you will not have any long-term negative tax consequences

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    Top Three "Do's" For Small Business Owners

    Retain copies of all receipts, especially those from any cash transactions

    Your accountant or bookkeeper will have a good record of any purchase you make with a debit card, credit card, or check. However, the only way they will know about a cash purchase is if you provide them with a copy of the receipt.

    Receipts justifying any ATM Withdrawals, Cash Withdrawals, and checks made payable to cash are now required by most Workers Compensation Insurance Audits. Any cash withdrawals that cannot be justified will be assumed to have been used to pay off-the-books workers and you will be charged for additional payroll.

    Take advantage of Section 179 Bonus Depreciation

    If you are planning to make any large purchases during the first quarter of the following year such as trucks, automobiles, or equipment, you may benefit from making that purchase before December 31 of the current year. Making the purchase in the current year may qualify you to expense the full purchase price under IRS Code Section 179 in order to quickly reduce your current-year taxable income. For 2007, the maximum deduction limit has been increased to $125,000

    Talk to your accountant about the Manufacturing Credit

    A business may be able to claim a manufacturing credit in 2007 equal to 6% of the taxable income from its qualified production activities. Due to new regulations issued this year, it may be easier to qualify for deductions.


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    Wednesday, February 27, 2008

    Employee Stock Option Plans

    Here is a question that was sent by a reader to Karen Klein, a columnist at the LA Times. Karen contacted me for a response because of some work we had done in Newsday:

    I am starting up a Web-based business and I'm leaning toward incorporation rather than LLC as the legal entity because I'd like to be able to attract employees by issuing stock in the future. I understand that there must be a board of directors in a corporation, and the board must hold meetings and vote to bring about actions. At this initial stage my company is just myself. Therefore I'm wondering if a one-person board of directors can legally exist, and how it can perform functions such as voting.
    KC, Elkridge, MD


    Great question.

    This is a common misconception that many small business owners have and it prevents a great deal of them from incorporating even though that may be their best option.

    Owning a corporation is not as daunting a task as you think. The common concept of a “board of directors” is not what is required for a small corporation. As the 100% owner of the business, you can act as the corporation’s sole director. You must hold an annual shareholders meeting during which minutes must be kept, a task that proves fairly easy for you as the sole shareholder.

    Back to your statement about issuing stock to employees...

    Although Employee Stock Ownership Plans (ESOPs) are typically a better fit under the C-Corporation structure, as a “solopreneur,” you should gain much greater tax advantages by operating as an S-Corporation (depending on your income level, you may be able to cut your total tax in half). Additionally, as the IRS continues to tighten their reigns on the tax laws surrounding stock options, ESOPs become less attractive to potential employees making them less likely to accept stock or stock options in lieu of pay. If you use the taxes saved by operating as an S-Corporation to replace stock options with higher salaries, you should be able to attract quality employees, retain full control and ownership of your company, and still have money leftover to pay yourself or reinvest in the business.


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    Year-End Tax Planning for Small Businesses

    What are some best practices for small business owners as the end of the year approaches?

    By far, the most effective form of tax planning involves meeting with their CPA at the end of August or beginning of September. At this time, two-thirds of the year is over and the accountant will have sufficient data to run an accurate tax plan. Barring any unforeseen circumstances that transpire during the fourth quarter, there is no reason why an accountant cannot determine what the client’s tax return will look like in March or April. Having this “mock tax return” prepared in August or September will allow the small business owner four months to implement tax savings strategies, implement tax deferral strategies, or pay in any tax due before the end of the year. Additionally, if it appears that the taxpayer is on pace to receive a large tax refund, the tax planning can work in the reverse by allowing the taxpayer to reduce their estimated taxes and/or payroll withholdings in order to increase their current cash flow (no reason to float the government an interest-free loan).

    What is the one thing every small business owner must do?

    Take a complete, accurate inventory count. For accrual-basis taxpayers, this is required. For cash-basis taxpayers, not only does it make good business sense to keep tabs on your inventory, but your inventory count could indicate that a switch to the accrual-basis of accounting will put your business in a better position in terms of taxes and audit risk.

    What is the one thing they must not do?

    Lose sight of whether they are a cash-basis or accrual-basis taxpayer. An accrual-basis taxpayer who tries to prepay all their upcoming expenses or hold off on depositing current year income in an effort to reduce current year income will be unpleasantly surprised to find out that they depleted their cash balance for no reason. When reporting on the accrual basis, income is reported when earned, not when deposited and expenses are reported when incurred, not when paid. On the flip-side, a cash basis taxpayer should not assume that they can deduct their December phone bill whether or not they pay it before the year is over. Cash-basis taxpayers report expenses when paid, not when incurred and they report income when received, not when earned.

    What is the most common mistake made this time of year?

    Many small business owners tie their profit into the amount of money they have in the bank. If they have $100k in the bank, they think their profit is $100k…if they have $0 in the bank, they think their profit is $0 (it’s a mistake that is more common than the average person would think). This leads to irrational end-of-year moves such as taking a large draw or S-Corporation distribution in an effort to reduce the ending bank balance, and in turn reduce their “profit.” Since items like draws and S-Corporation distributions are not tax deductible, they do nothing to decrease the business profitability. In cases where the owner distributes more than is available for distribution, they run the risk of reducing their basis in the business, which could lead to a situation where any losses they incurred cannot be deducted in the current year.

    Along the same lines, many small business owners rush to make large equipment purchases at the end of the year in order to reduce their profits. However, certain businesses that do not qualify to expense these equipment purchases under Section 179 bonus depreciation rules, put themselves into a trap. If during any tax year more than 40% of new assets are placed into service during the last three months of the tax year, the Midquarter Convention applies. When using the Midquarter Convention, you generally receive a lower than normal amount of depreciation for the year. If this is the scenario that the small business owner is in, they are better off using those monies to pay expenses rather than purchase equipment.


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    Sunday, February 24, 2008

    Incorporating Out-of-State

    For my first few posts, I have decided to address questions that frequently come up during my initial consultations with new clients. Here are a few common questions/misconceptions about forming a corporation or LLC in a different state than you live in:

    Q: I am a New York resident and business owner. I have been told that I can save a great deal of tax each year if I establish my company in a tax-free state. Is it really this easy to avoid New York State income taxes?

    A: No, it is not that simple. The way New York handles multi-state tax issues is by allowing a credit against NY income taxes equal to the amount of income taxes paid to other states. If you are a full-year or part-year resident of NY and if any part of your income was taxed by another state, local government, or the District of Columbia, you may claim a credit against your NY State tax. Therefore, if your income is not taxed by the other state, your credit against NY income tax equals zero and you end up paying the full NY income tax rate.

    Q: What about other benefits of establishing my business in another state such as the anonymity provided by Nevada Limited Liability Companies (LLCs)?

    A: Though Nevada is heralded as a state that provides business owners anonymity, this only holds true for shareholders of a Nevada corporation, not a Nevada LLC. Members and managers of a Nevada LLC must be disclosed on annual reports that immediately become public information. Additionally, if you are involved in arms-length transactions with your clients and/or customers, they meet you face-to face and they know who you are. Therefore anonymity is only valuable in certain industries where that face-to-face contact is not prevalent. Further, by establishing your New York-based business in Nevada, you will have to undergo additional filing fees in order to do business and report your business activity in NY.

    Q: With all the talk about establishing entities out-of-state, what is my best course of action?

    Unless you are operating a large business, most small and mid-size companies are better off establishing their business in the state that they plan to do business in. This ensures that you do not have to shoulder the burden of additional reporting requirements, administrative provisions, state filing fees, accounting fees, and legal fees. Consult with both your attorney and your CPA before going online to setup a company in a different state.


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    Home-Based Businesses and Audit Risk

    For my first few posts, I have decided to address questions that frequently come up during my initial consultations with new clients. Here is one about the audit risk aspects of operating a home-based business:

    Q: I operate a small business out of my house. The thought of a potential IRS audit makes me lose sleep at night. Is there anything I can do to eliminate or reduce my chances of being audited?

    A: There are many ways to minimize your chances of being audited. First and foremost is to ensure that you avoid some of the more highly audited forms.

    As a Sole Proprietor (sometimes referred to as a DBA), you are required to report your business income and expenses on Schedule C. Filing this schedule means that you fall into the highest audit risk category and find yourself with an audit risk of approximately 2.7%. A simple remedy to this problem is to incorporate. By incorporating you reduce your risk of an audit to approximately .3%, making you about nine times less likely to be audited in a given year.

    Another form that shifts your tax return into the audit field at an alarming rate is Form 8829 (Expenses for Business Use of Your Home) which is used to claim the home office deduction. This form tends to catch the eye of the IRS due to the fact that many people have abused this deduction in the past by claiming a larger home office than they actually had or by deducting expenses on an office that is not completely dedicated to business use. In addition to the huge audit risk that this form creates, the home office deduction typically costs you more taxes in the long run due to the reduction of your capital gain exclusion in the year you sell your house. So, why draw unwanted attention to your tax return if you are not even receiving a financial benefit?

    Other simple tips to protect yourself from an IRS audit include not having your tax return prepared by hand, making sure your reported income supports your living expenses and other deductions, not rounding off deductions (round numbers make it appear that you are guesstimating while exact figures appear to be taken from actual records) and hiring a reputable tax preparer to prepare your return. Tax preparers whose tax returns are audited frequently will be flagged as disreputable tax preparers opening up their entire client base to IRS audits. If your tax preparer is "creating" deductions for you or generating large refunds that you know you are not entitled to, it is only a matter of time before his scam comes crashing down.


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