Almost a year ago, I presented my demo workshop titled “IRS Compliance and Strategy” for the University of Texas at San Antonio, Small Business Development Center (UTSA SBDC). My mentor, Ruben Lopez, MBA, and I identified the need for this class in our conversations. What I thought was important for a small business owner to know, Ruben, thought was important too. He suggested I create a class and if requested, present a demo, which I did, on 11/22/16. Since that time, I have taught this class, thankfully, several times for times for them and I look forward to teaching more.
While the students were learning from me, I, too, was learning from them. Their questions identified new topics that could be taught in class.
Every well-built house begins with a blueprint; I created this class as an IRS Business Basics- a blueprint for entrepreneurs and new small business owners. In today’s “Sharing Economy”, “small business owners” include independent contractors and freelancers. If you are just collecting your 1099-Miscellaneous forms and not tracking expenses, you are probably paying too much tax.
What we don’t know can often hurt us financially and education can prevent a problem.
This blog was created to help others learn, understand, and apply general income tax rules and procedures. I thought the alphabet format would be a fun way to teach tax terms & topics and hope you think so too.
A is for:
- Accounting Method is how income and expenses are reported for taxation purposes:
- Cash Method: Income is reported when constructively received (not earned) and expenses when paid (not incurred).
- Accrual Method: Income is reported when earned (not necessarily received) and expenses when incurred (not necessarily paid).
B is for Basis of an Asset
- Basis, in an asset, is its cost plus sales tax and other expenses incurred to acquire the property or to place the asset in service for tax purposes. This basis is used to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange, or other disposition of the property
- The Initial basis can be increased or decreased for various items = Adjusted Basis
- Maintain your basis for each asset to determine the accurate gain/loss
- Retain supporting documentation for the life of the asset
- Basis Limitation, is the limit on deducting losses, to the extent of the shareholder’s basis in the S Corporation or partner’s basis in the partnership
C is for Corporation
- C-Corporation: “Double-Taxation” applies: the profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends
- S-Corporation: Corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S Corporations report the flow-through of income and losses on their personal tax returns
D is for Depreciation:
- Depreciation is an annual deduction that allows taxpayers to recover the cost of property used in a trade or business or held for the production of income. The amount of depreciation depends on the basis of the property, its recovery period, and the depreciation method.
- Depreciation Recapture: Amount of depreciation or section 179 deduction that must be reported as ordinary income when property is sold at a gain.
E is for: Estimated Tax
- Method used to pay tax on income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents, alimony)
F is for:
- Failure to File (FTF) Penalty is 5%, of the additional taxes owed amount, for every month, or fraction of a month, the return is late, up to a maximum of 25%.
- Failure to Pay (PTF) Penalty is the most common penalty issued by the IRS. 0.5% per month, or fraction of a month, up to 25%.
Tax Tip: Note there are 2 penalties. If you cannot afford to pay, at least file, and save yourself the cost of 1 penalty.
G is for Gig Economy:
- Also known as the Sharing Economy or On Demand economy
- File and Pay estimated taxes
- Note that Self-Employment Tax is in addition to the Income Tax
- Expect that a 1099-Misc will be issued to the IRS and to you if payments were more than $600/annually
H is for: “Hobby”
- An activity is either a Hobby or a Business
- An activity is, generally, presumed to be a Hobby if a profit is not earned in at least 3 of 5 taxable years
- Tax deductions for hobby losses are limited to the income produced
I is for Independent Contractor
- The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
- The basic rule is that you must file a 1099–MISC whenever you pay an unincorporated independent contractor (sole proprietor or member of a partnership or LLC) — $600 or more in a year for work done in the course of your trade or business.
J is for Joint and Several Tax Liability
- Married Filing Joint: Both you and your spouse are generally responsible for the tax and interest or penalties due on the return
- This means that if one spouse doesn’t pay the tax due, the other may have to
- Or, if one spouse doesn’t report the correct tax, both spouses may be responsible for any additional taxes assessed by the IRS
K is for Kiddie Tax:
Investment income of a child is taxed at the parent’s tax rate
L is for Limited Liability Company (LLC)
- Notice that this is not a corporation
- An LLC is created by state statue and is not an IRS filing status
M is for: Meals and Lodging:
- You can deduct the cost of meals and lodging if your business trip is overnight or long enough that you need to stop for sleep or rest to perform your duties. In most cases, you can deduct only 50% of your meal expenses.
- You can deduct entertainment expenses only if they are both ordinary and necessary and meet one of the following tests: Directly –Related test or Associated test
- In general, you can deduct only 50% of your business-related meal and entertainment expenses
N is for Net Operating Loss
- If your deductions for the year are more than your income for the year (line 41 of your Form 1040 is a negative number), you may have a net operating loss (NOL). You can use an NOL by deducting it from your income in another year or years.
O is for Ordinary and Necessary:
- A business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business.
P is for Profit and Loss
- Profit & Loss statements are required for small business loans, for a mortgage, and to determine tax owed for the IRS and/or your state
- Review at least quarterly to determine if Self-Employment Tax & Estimated Tax payments are required
Q is for Quarterly Tax Reporting & Payments
- The U.S. Tax system is “Pay as You Go” and generally not at the end of the year
- Accounting records must be kept current to determine if quarterly payments are required
R is Refundable Credit
- A Refundable tax credit means you get a refund, even if it is more than you owe
- A Non-Refundable tax credit means you get a refund only up to the amount that you owe
S is for Self-Employment Tax:
- 2017 Self-Employed Tax Rate, on net earnings of $400+, is 15.3%
- 4% for Social Security and 2.9% Medicare Tax = 15.3%
- For 2017, Social Security wages are capped at $127,200
- Medicare Tax applies to all income; i.e. a wage limit does not apply
T is for Taxable Income
- Gross income, minus any adjustments to income, any allowable exemptions, and either itemized deductions or the standard deduction = Taxable Income
U is for Use Tax
- A tax on purchases made outside the state for use in the state. Residents are responsible for paying the tax on purchases for which no state sales tax has been charged. The tax applies to transactions that would be subject to sales tax if the purchase were made in the state.
V is for Vehicle
- IRS Deduction for operating a vehicle for business, charitable, medical, or moving; track each separately- different rates apply
- Standard Mileage Rates or the Actual Costs of using the vehicle
- A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle.
W is for Withholding (Federal Income Tax)
- To avoid an Underpayment Penalty, estimate your 2017 tax liability, to see if you should adjust your withholding, or make an estimated payment before year-end
X is a tough one; X “Marks the Spot” or Solving for an Unknown:
- You can fill in the blank on this one, or choose
- X = Your Break Even Point
- Unknown is your 2017 estimated tax liability
Y is for Year-End Tax Planning
- There is still time to setup an appointment for year-end tax planning by December 31. Being in control of your finances & taxes is a great stress reliever.
Z is for Zero Based Budgeting (ZBB)
ZBB is a method to prepare cash flow budgets & operating plans. Each year these start from scratch and do not use incremental budgeting, in which past sales and expenses are assumed to continue. ZBB requires a systematic basis for resource allocation; cost-benefit analysis and priority ranking are part of the process.
©2017 Deborah Fox, CPA
Thanks for reading.
To your success,
Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. Deb thinks this is the fun part of tax because it makes a financial difference for her clients, their business, and their families.
Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.
E-Mail me @ email@example.com
Facebook: Deborah Ann Fox, CPA
The blog is provided as general information only and should not be considered a substitute for the advice and services of an attorney or Certified Public Accountant.