Small Business and Taxes – Back to Biz Monday

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

One of the biggest hurdles you’ll face in running your own business is staying on top of your numerous obligations to federal, state, and local tax agencies. Tax codes seem to be in a constant state of flux making the Internal Revenue Code barely understandable to most people.

The old legal saying that “ignorance of the law is no excuse” is perhaps most often applied in tax settings and it is safe to assume that a tax auditor presenting an assessment of additional taxes, penalties, and interest will not look kindly on an “I didn’t know I was required to do that” claim. On the flip side, it is surprising how many small businesses actually overpay their taxes, neglecting to take deductions they’re legally entitled to that can help them lower their tax bill.

Preparing your taxes and strategizing as to how to keep more of your hard-earned dollars in your pocket becomes increasingly difficult with each passing year. Your best course of action to save time, frustration, money, and an auditor knocking on your door, is to have a professional accountant handle your taxes.

Tax professionals have years of experience with tax preparation, religiously attend tax seminars, read scores of journals, magazines, and monthly tax tips, among other things, to correctly interpret the changing tax code.

When it comes to tax planning for small businesses, the complexity of tax law generates a lot of folklore and misinformation that also leads to costly mistakes. With that in mind, here is a look at some of the more common small business tax misperceptions.

1. All Start-Up Costs Are Immediately Deductible

Business start-up costs refer to expenses incurred before you actually begin operating your business. Business start-up costs include both start up and organizational costs and vary depending on the type of business. Examples of these types of costs include advertising, travel, surveys, and training. These start up and organizational costs are generally called capital expenditures.

Costs for a particular asset (such as machinery or office equipment) are recovered through depreciation or Section 179 expensing. When you start a business, you can elect to deduct or amortize certain business start-up costs.

For tax years beginning in 2010, you can elect to deduct up to $10,000 of business start-up costs paid or incurred after 2009. The $10,000 deduction is reduced (but not below zero) by the amount such start-up costs exceed $60,000. Any remaining costs must be amortized.

2. Overpaying The IRS Makes You “Audit Proof”

The IRS doesn’t care if you pay the right amount of taxes or overpay your taxes. They do care if you pay less than you owe and you can’t substantiate your deductions. Even if you overpay in one area, the IRS will still hit you with interest and penalties if you underpay in another. It is never a good idea to knowingly or unknowingly overpay the IRS. The best way to “Audit Proof” yourself is to properly document your expenses and make sure you are getting good advice from your tax accountant.

3. Being incorporated enables you to take more deductions.

Self-employed individuals (sole proprietors and S Corps) qualify for many of the same deductions that incorporated businesses do, and for many small businesses, being incorporated is an unnecessary expense and burden. Start-ups can spend thousands of dollars in legal and accounting fees to set up a corporation, only to discover soon thereafter that they need to change their name or move the company in a different direction. In addition, plenty of small business owners who incorporate don’t make money for the first few years and find themselves saddled with minimum corporate tax payments and no income.

4. The home office deduction is a red flag for an audit.

While it used to be a red flag, this is no longer true–as long as you keep excellent records that satisfy IRS requirements. Because of the proliferation of home offices, tax officials cannot possibly audit all tax returns containing the home office deduction. In other words, there is no need to fear an audit just because you take the home office deduction. A high deduction-to-income ratio however, may raise a red flag and lead to an audit.

5. If you don’t take the home office deduction, business expenses are not deductible.

You are still eligible to take deductions for business supplies, business-related phone bills, travel expenses, printing, wages paid to employees or contract workers, depreciation of equipment used for your business, and other expenses related to running a home-based business, whether or not you take the home office deduction.

6. Requesting an extension on your taxes is an extension to pay taxes.

Extensions enable you to extend your filing date only. Penalties and interest begin accruing from the date your taxes are due.

7. Part-time business owners cannot set up self-employed pensions.

If you start up a company while you have a salaried position complete with a 401K plan, you can still set up a SEP-IRA for your business and take the deduction.

A tax headache is only one mistake away, be it a missed payment or filing deadline, an improperly claimed deduction, or incomplete records and understanding how the tax system works is beneficial to any business owner, whether you run a small to medium sized business or are a sole proprietor.

And, even if you delegate the tax preparation to someone else, you are still liable for the accuracy of your tax returns. If you have any questions, don’t hesitate to give us a call today. We’re here to assist you.

~Larry Stone

Larry D. Stone,  Stone CPA

970.668.0772,    970.668.0434,

larry@stone-cpa.com – Colorado Tax Coach

Author of “The Secrets of a Tax Free Life”

Hobby vs. Business – Colorado Tax Coach

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

Millions of Americans have hobbies such as photography, sewing, woodworking, fishing, gardening, stamp and coin collecting, but when that hobby starts to turn a profit, it might just be considered a business by the IRS.

Definition of a Hobby vs a Business

The IRS defines a hobby as an activity that is not pursued for profit. A business, on the other hand, is an activity that is carried out with the reasonable expectation of earning a profit.

The tax considerations are different for each activity so it’s important for taxpayers to determine whether an activity is engaged in for profit as a business or is just a hobby for personal enjoyment.

Of course, you must report and pay tax on income from almost all sources, including hobbies. But when it comes to deductions such as expenses and losses, the two activities differ in their tax implications.

Is Your Hobby Actually a Business?

If you’re not sure whether you’re running a business or simply enjoying a hobby, here are some of the factors you should consider:

• Does the time and effort put into the activity indicate an intention to make a profit?

• Do you depend on income from the activity?

• If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?

• Have you changed methods of operation to improve profitability?

• Do you have the knowledge needed to carry on the activity as a successful business?

• Have you made a profit in similar activities in the past?

• Does the activity make a profit in some years?

• Do you expect to make a profit in the future from the appreciation of assets used in the activity?

An activity is presumed to be for profit if it makes a profit in at least three of the last five tax years, including the current year (or at least two of the last seven years for activities that consist primarily of breeding, showing, training, or racing horses).

The IRS says that it looks at all facts when determining whether a hobby is for pleasure or business, but the profit test is the primary one. If the activity earned income in three out of the last five years, it is for profit. If the activity does not meet the profit test, the IRS will take an individualized look at the facts of your activity using the list of questions above to determine whether it’s a business or a hobby. (It should be noted that this list is not all-inclusive.)

Business Activity: If the activity is determined to be a business, you can deduct ordinary and necessary expenses for the operation of the business on a Schedule C or C-EZ on your Form 1040 without considerations for percentage limitations. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.

Hobby: If an activity is a hobby, not for profit, losses from that activity may not be used to offset other income. You can only deduct expenses up to the amount of income earned from the hobby. These expenses, with other miscellaneous expenses, are itemized on Schedule A and must also meet the 2 percent limitation of your adjusted gross income in order to be deducted.

What Are Allowable Hobby Deductions?

If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity.

Note: Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”

Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. These deductions must be taken in the following order and only to the extent stated in each of three categories:

• Deductions that a taxpayer may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.

• Deductions that don’t result in an adjustment to the basis of property, such as advertising, insurance premiums, and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.

• Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.

If your hobby is regularly generating income, it could make tax sense for you to consider it a business because you might be able to lower your taxes and take certain deductions.

Give us a call if you’re not sure whether your hobby is actually a business and we’ll help you figure it out.

Larry D. Stone,  Stone CPA

970.668.0772,  970.668.0434,  888.668.0772

larry@stone-cpa.com – Colorado Tax Coach

“Like” This

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

America’s economy continues to sputter. But stocks are picking up steam and flirting with four-year highs. We’re even seeing new “dot-coms” hitting the market. Last May, the social networking site LinkedIn went public at $45 per share, then leaped to $94.25 in its first day of trading. Internet coupon vendor Groupon opened in November at $20 per share, then jumped 31% on its first day of trading. And earlier this month, Facebook filed registration papers with the Securities and Exchange Commission for what may be the hottest IPO since Google.

Companies typically go public to raise money to expand. But Facebook doesn’t really need cash from an IPO. The company made nearly $4 billion in advertising revenue in 2011. So why go public?

Well, companies also go public to let founders and early investors cash out. Mark Zuckerberg, Facebook’s 27-year-old founder, is already a “paper” billionaire, ranked #14 on the Forbes 400 list of richest Americans. (Not many entrepreneurs find themselves richer than Scrooge McDuck while still at an age that they watch Scrooge McDuck.) But Facebook’s IPO will give Zuckerberg and fellow early investors liquidity, converting paper wealth into cash for the houses, charitable gifts, and other spending that new dot-com millionaires historically indulge in.

The IPO will also stick Zuckerberg with a historically large tax bill. (You knew that was coming, right?) In fact, one of the big reasons the company is going public in the first place is to give Zuckerberg a way to pay taxes when he exercises options to buy even more stock.

Here’s how it works. For tax purposes, the value of most stock options is treated as compensation and fixed the day you exercise them — whether you actually sell them or not. Let’s say you pay $5 to exercise a share of your employer’s stock, on a day when that stock is worth $25. Your company gets a deduction for that $20 per share, even though there’s no cash outlay. That’s great for the company. But at the same time, you’ll owe immediate tax on $20 of income, even if you hold the stock in hope of future appreciation. (If the stock tanks before you actually sell, you still owe tax on that gain.) That may not be so great for you!

Zuckerberg currently owns 414 million shares of Facebook. He also has options to buy another 120 million shares for — get this — just six cents each. Zuckerberg has announced plans to exercise those options and sell enough shares to cover his taxes. We don’t know yet what Facebook shares will trade for. However, private-market trades have valued shares at $40 each. If Zuckerberg exercises all 120 million options when shares are valued at that price, his taxable gain will be nearly $5 billion. He’ll owe 35% to the IRS, plus 10.3% to the state of California, for a total tax bill of over $2 billion. That’s right, billion with a “b.” Can you imagine signing a return with a billion-dollar tax bill? How about signing a check for that much — payable to the IRS!

The important thing to realize here is that Zuckerberg’s tax bill came as no surprise. It’s actually the result of careful planning. Remember, Zuckerberg’s pain is Facebook’s gain. The strategy will probably give Facebook enough deductions to wipe out the entire tax on its 2011 profit, plus refunds from 2009 and 2010, plus even more to carry forward.

Think about that the next time you click the “Like” button on your computer. And remember, we’re here to bring the same sort of smart tax planning to your business.

~Larry

Larry D. Stone,  Stone CPA

970.668.0772,  970.668.0434,  888.668.0772

larry@stone-cpa.com – Colorado Tax Coach

Author of “The Secrets of a Tax Free Life”

Jedi Tax Planning – Back to Biz Monday

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

Filmmaker George Lucas has been a Hollywood success since 1973, when he spent just $775,000 to produce American Graffiti — then watched it go on to gross over $200 million. Lucas has influenced a generation of filmmakers and films, as director (19 titles), producer (67 titles), writer (81 titles), and even an actor (he played an uncredited “Alien on TV Monitor” in the first Men in Black). Of course, he’ll always be best known as creator of the Star Wars series, which popularized the “space opera” genre for a galaxy of fans.

Last month, Lucas announced that he’s selling his production company, Lucasfilms, to The Walt Disney Company for $4.05 billion in cash and stock. And it should hardly come as a surprise ending that he found a way to beat the IRS that’s almost as powerful as launching a proton torpedo down the Death Star’s exhaust port.

How did he do it? Elaborate special effects? Computer-generated imaging? Nope. He did it just by selling now, in 2012.

We have no idea how the evil Empire collected taxes a long time ago, in a galaxy far, far away. (We suspect that R2D2 kept awesome records in case he was audited; Darth Vader hid his money on Endor, a forest moon bearing a striking resemblance to the Cayman Islands; and Chewbacca never bothered to file at all.) But here in the U.S., gains from the sale of a business are treated as capital gains and subject to tax up to 15%. Lucas is taking half of his proceeds in Disney stock, so that part escapes tax for now. (He’ll pay if he sells those Disney shares sometime down the road.) But that still leaves up to $2 billion in fully taxable cash gains. And that means up to $300 million in tax for Uncle Sam.

At least, that’s how it works this year. On January 1, the Empire strikes back, when those Bush-era rates expire. Unless Washington gives us a new hope, that capital gains rate jumps to 20%. President Obama has said he wants to extend the current rates for income under $200,000 ($250,000 for joint filers), and the Senate has passed a bill to do just that. But if the 20% Clinton capital gains rate returns, at least for guys in Lucas’s bracket, selling in 2013 could have cost him up to $100 million more in immediate tax. That’s at least enough to recondition a Millenium Falcon or two!

January 1 also marks the start of a new phantom menace, the “Unearned Income Medicare Contribution,” on investment income, including capital gains, for those earning above that same $200,000 threshold. The new Medicare tax is “just” 3.8% — but 3.8% of $2 billion is still a hefty $76 million.

The sale also represents smart estate planning for Lucas, who is 68. While generations of fans hope to see him shepherd the final three Star Wars films to the theatre, the sale will spare his heirs the challenge of managing his affairs at his death. Lucas has already announced plans to donate the bulk of his estate to educational charities, and the gifts he’s already made, including $175 million to his alma mater University of Southern California, will surely ease the tax bite on that transfer.

Selling a business is one of the toughest productions any entrepreneur directs. Making the most of that opportunity takes bits of Luke Skywalker’s drive, Han Solo’s skill, and Obi-Wan Kenobi’s wisdom. And keeping the most of your proceeds takes the right tax advice. That’s why we’re here — to give you a plan to keep the most of your legacy. And remember, we’re here for your family, friends, and colleagues, too. May the Force be with you!

~Larry

Larry D. Stone,  Stone CPA

970.668.0772,   970.668.0434,   888.668.0772

larry@stone-cpa.com – Colorado Tax Coach

Author of “The Secrets of a Tax Free Life”

Relief for “Superstorm” Sandy – Back to Biz Monday says Donate!

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

Hurricane Sandy roared ashore over a week ago, interrupting lives and yes the election. We’ll be addressing the election results next week, especially as we get more guidance on what to expect for your taxes. We are impressed, as always, with how a natural disaster brings out the best in Americans, and we’re pleased to see both Democrats and Republicans joining together to help those most affected by the storm. There are still many who need assistance on the East Coast!

The IRS gives generous tax deductions to help make our own generous charitable gifts go further. So this week we’re writing to help you make the most of efforts you might make to support storm victims — or any other year-end charitable gifts.

• You can deduct up to 50% of your adjusted gross income for cash gifts you make to so-called “501(c)(3) organizations,” or public charities working on behalf of storm victims. These include the American Red Cross and similarly recognizeable groups.

• If you give more than $250 in any single gift, you’ll need a written receipt from the recipient, dated no later than the filing date of your return.

• Gifts of food, clothing, furniture, electronics, or household items are deductible at “fair-market value,” such as the price you would get for them at a resale shop. Consider using software, available at any office-supply store, for tracking your gifts and their value. You might be surprised at how much you can save!

• Gifts of cars, trucks, and boats are a little trickier. Congress has cracked down on inflated car and truck deductions. If you donate a vehicle, you can deduct the fair-market value only if the charity actually uses it (such as a church using a van to drive its parishioners). If the charity sells the vehicle, your deduction is limted to the amount the charity actually realizes on the sale. And if that amount is more than $500, you’ll have to attach a certification to your return that states the vehicle was sold in an arms-length sale and includes the gross proceeds from that sale.

• Donations you make by text message are deductible like any other cash gifts. You can use your phone bill to substantiate your deduction.

The IRS cautions us all to seek out qualified charities, and warns that bogus requests for charities that simply don’t exist are common after natural disasters. The IRS also announced that they would give businesses and tax preparers affected by the hurricane an extra seven days to file payroll and excise tax returns that were due on October 31.

December 31 is approaching faster than you’d like, and that means time is running out for year-end tax planning. But it’s not too late to take concrete steps to cut your 2012 taxes. What are your year-end financial goals? Helping the victims of the storm? Saving for your dream retirement? Helping finance your children’s or grandchildren’s education? Odds are good that we can help you save taxes while you do it. And remember, we’re here for your family, friends, and colleagues too! Start Here:

Donate to the Red Cross: http://www.redcross.org/charitable-donations

~Larry

Larry D. Stone,  Stone CPA

970.668.0772,   970.668.0434,   888.668.0772

larry@stone-cpa.com – Colorado Tax Coach, Author of “The Secrets of a Tax Free Life”

Photo Credit: Nancy Augustine

Advantages of Keeping Good Records – Biz Monday

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

You can avoid headaches at tax time by keeping track of your receipts and other records throughout the year. Good record-keeping will help you remember the various transactions you made during the year, which in turn may make filing your return less, well, taxing.

Records help you document the deductions you’ve claimed on your return. You’ll need this documentation should the IRS select your return for examination. Normally, tax records should be kept for three years, but some documents – such as records relating to a home purchase or sale, stock transactions, IRA, and business or rental property – should be kept longer.

In most cases, the IRS does not require you to keep records in any special manner. Generally speaking, however, you should keep any and all documents that may have an impact on your federal tax return:

• Bills

• Credit card and other receipts

• Invoices

• Mileage logs

• Canceled, imaged, or substitute checks or any other proof of payment

• Any other records to support deductions or credits you claim on your return

Good record-keeping throughout the year saves you time and effort at tax time. For more information on what kinds of records you should keep, call our office.

~Larry

Larry D. Stone,  Stone CPA

970.668.0772,  970.668.0434,  888.668.0772

larry@stone-cpa.com – Colorado Tax Coach

Employee Relocation in Todays Market

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

Autumn is often the time you find folks relocating. Many companies have questions about what to do with an employee’s home when he or she is moved to a new job location, especially with the real estate market is in a downturn throughout much of the country.

Typically, the employer wants to protect the employee against financial loss on a “forced” sale of the home. Here are the most common ways to do that, and their consequences to the employee:

The employer reimburses the employee’s financial loss. Here the employer has the home appraised and agrees to pay the employee the difference between the appraised fair market value and any lesser amount the employee gets on the sale. Such reimbursement would cover the employee’s costs of the sale.

Note: The financial loss here is not the same as a tax loss. The financial loss is the home’s value less what the employee collects under “forced sale” conditions. In the current real estate market, the value is not always clearly determined. The relocating employee might think the home is worth more, based on earlier appraisals or comparative sales. A tax loss is the property’s tax basis (cost plus capital investments) less what’s collected on the sale.

If the employee has a gain on the sale (the amount collected on the sale exceeds the basis), gain can be tax-exempt up to $250,000 ($500,000 on certain husband-wife sales). However, tax loss on the sale of one’s residence is not deductible.

The employer’s reimbursement of the employee’s financial loss is taxable pay to the employee. Employers who want to shelter the employee from any tax burden on what is usually an employer-instigated relocation may “gross-up” the reimbursement to cover the tax. But gross-up can be costly. For example, a grossed-up income tax reimbursement for a $10,000 loss would be $15,385 for an employee in the 35% bracket – more where Social Security taxes or state taxes are also grossed-up.

Employer buys the home. Few employers directly buy and sell employees’ homes. But many do this indirectly, effectively becoming the homes’ owners, through use of relocation firms acting as the employers’ agents. An IRS ruling shows how to do this with no tax on the employee:

Option 1. The relocation firm as employer’s agent buys the home for its appraised fair market value, and later resells it. The firm collects a fee from the employer, which will cover sales costs and any financial loss to the firm on resale. The IRS now says that this fee is not taxable to the employee. Also, the employee’s gain on the sale to the relocation firm qualifies for the tax exemption under the limits described above ($250,000 or $500,000).

Option 2. The relocation firm offers to buy the home for its appraised value, but the employee can choose to pursue a higher price through a broker he or she chooses from a list provided by the relocation firm. If a higher offer is made, the relocation firm pays that price to the employee (whether or not the home is then sold to that bidder). Here again, the employee is not taxed on the firm’s fee and the gain is tax exempt under the above limits.

Tip: Either option works for the employee, letting him or her realize full value on the sale of the home (with possibly greater value through Option 2), without an element of taxable pay.

Caution: If the deal is structured so that the relocation firm facilitates a sale from the employee to a third-party buyer (rather than to the relocation firm), the employer’s payment of the relocation firm’s fee is taxable to the employee.

The Employer’s Side

Reimbursing the employee’s loss. This is fully deductible as a business expense, as would be any additional amount paid as a gross-up.

Note: It’s fully deductible, but it may be more costly, before and after taxes, than buying the home for resale through the relocation firm.

Note: Paying the relocation fee only, without buying the home, as in the “Caution” above, is also fully deductible, as would be any gross-up amount on that fee.

Buying the home. The change in the IRS rule was good news for employees, but it gave nothing to employers, whose tax treatment wasn’t covered. The official IRS position is that employer costs (other than carrying costs such as mortgage interest, maintenance, and fees to a relocation management company) are deductible only as capital losses, which, for corporate employers, are deductible only against capital gains. Taxpayer advocates tend to argue that employer costs here are fully deductible ordinary costs of doing business.

Questions?

Are you an employee who is being relocated this fall? Are you wondering about the sale of your home and the tax implications for you? We can answer your questions. Just give us a call.

Larry D. Stone,  Stone CPA

970.668.0772,  970.668.0434,  888.668.0772

larry@stone-cpa.com – Colorado Tax Coach

Getting an Accurate Business Valuation – 3 Tips for Business Monday

This article was originally Published in Mountain Town Magazine. https://mtntownmagazine.com/

If you’re conscientious about financial reporting, you may already have a sense of your company’s worth, but in some instances you might need a formal business valuation, such as:

• For certain transactions. Selling your business? Planning an IPO? Need financing?

• For tax purposes. Includes estate planning, stock option distribution, and S Corporation conversions.

• For litigation. Needed in cases like bankruptcy, divorce, and damage determinations.

There isn’t a single formula for valuing a business, but there are generally-accepted measures that will give you a valid assessment of your company’s worth. Here are some tips that will help you get a more accurate business valuation.

1. Take a close look at how your business operates. Does it incorporate the most tax-efficient structure? Have sales been lagging or are you selling most of your merchandise to only a few customers? If so, then consider jump-starting your sales effort by bringing in a seasoned consultant.Do you have several products that are not selling well? Maybe it’s time to remove them from your inventory. Redesign your catalog to give it a fresh new look and make a point of discussing any new and exciting product lines with your existing customer base.It might also be time to give your physical properties a spring cleaning. Even minor upgrades such as a new coat of paint will increase your business valuation.

2. Keep in mind that business valuation is not just an exercise in numbers where you subtract your liabilities from your assets, it’s also based on the value of your intangible assets.It’s easy to figure out the numbers for the value of your real estate and fixtures, but what is your intellectual property worth? Do you hold any patents or trademarks? And what about your business relationships or the reputation you’ve established with existing clients and in the community? Don’t forget about key long-term employees whose in-depth knowledge about your business also adds value to its net worth.

3. Choose your appraisal team carefully. Don’t try to do it yourself by turning to the Internet or reading a few books. You may eventually need to bring in experts like a business broker and an attorney, but your first step should be to contact us. We have the expertise you need to arrive a fair valuation of your business.If you need a business valuation for whatever reason, give us a call today.