Death and Taxes

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Life is like a day. Sunrise, Sunset. A lot of us anticipate that we will die, later in life and if we are “fortunate”, life will give us notice before we do.

Unfortunately, we know, objectively, that is not always true. We all know someone that left us too early. I have had that happen 3 times, just since 6/7/18.

“Life is a movie. Death is a photograph” – Susan Sontag

When someone we love dies, our natural emotional response is grief. Taxes are the furthest thing from our mind-, and, as they should be. This is true for me and for many others that I know or have helped over the years. It is probably true for you, too.

Life dictates change, and even though we do not like it, sometimes our priorities need to change as well. There are things we must take care of, some of which can be time sensitive.

This blog was written to help others learn a little about death and taxes. In my experience, people are often very surprised (or shocked) to learn that tax returns may be required when someone dies. This blog is written in general terms because for many, state rules also apply. Ask your experienced Tax Professional for guidance, as needed.

There are three (3) possible IRS tax returns that may need to be filed after a death:

  1. The Final 1040
  2. Form 1041
  3. Form 706

 

  1. The IRS Final 1040 (Individual Income Tax Return)
  • Income received prior to and including death is reported on the decedent’s Final 1040 tax return
  • Upon death of the taxpayer a new entity, the estate, is created
  • A revocable trust becomes irrevocable upon the grantor’s death. From that point on, do not report income on the grantor’s individual income tax return, use Form 1041
  • The due date remains April 15 for calendar-year taxpayers
  • Your first step, prior to starting the final Form 1040, is to determine who is responsible to file and sign the return
  • If appointed, the representative files Form 56, Notice Concerning Fiduciary Relationship with the IRS
  • The person filing the return should write “DECEASED,” the decedent’s name and the date of death across the top of Page 1 of the tax return. Mail the form to the IRS Service Center for the area in which the person signing the return lives.

 

  1. Form 1041: Estate Income Tax Return
  • Income received after death is reported on IRS Form 1041
  • Notice that Form 1041 and Form 706 both use the word “estate” – learn to distinguish between the two (2) Forms; Form 1041 is for income (like the 1040)
  • An estate is comprised of all assets owned at the time of death, whether they are distributable through the probate process or an alternate way
  • The decedent and their estate are separate taxable entities; obtain an Employer Identification Number (EIN) for their estate or trust from the IRS website
  • The fiduciary of a domestic decedent’s estate, trust, or bankruptcy estate files Form 1041 to report:
  1. The income, deductions, gains, losses, etc. of the estate or trust
  2. The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries
  3. Any income tax liability of the estate or trust
  4. Employment taxes on wages paid to household employees

 

Who Must File Form 1041:

Domestic Estate that has:  Gross income for the tax year of

  • $600 or more, or
  • A beneficiary who is a non-resident alien

 Domestic Trust  that has:

  • Any taxable income for the tax year
  • Gross income of $600 or more
  • A beneficiary who is a non-resident alien

 

Decedents Estates have an Exemption, but do not have a Standard Deduction.

Exemption:

  • Decedents’ Estate : A decedent’s estate is allowed a $600 exemption
  • Trusts required to distribute all income currently. A trust whose governing instrument requires that all income be distributed currently is allowed a $300 exemption, even if it distributed amounts other than income during the tax year

 

Form 1041 – Due Date

  • Form 1041 is due by the 15th day of the 4th month after the end of the estate’s tax year. For taxpayers choosing a calendar year, the due date is April 15
  • If you are preparing Form 706, you should prepare Form 706 at the same time as Form 1041 to determine where to report certain deductions

 

Tax

  • Like IRS Form 1040, the Estate Income tax rate for Form 1041 is progressive, but the rates rise very quickly. For example, the 2017 rate is 39.6% for income of $12,500 or more
  • The 2018 tax rate, inclusive of tax reform, is 37% for income of $12,500 or more

 

Important Form 1041 Takeaways:

Earlier in this post, I highlighted the following fragment in bold, any income tax liability of the estate or trust, and now, I will explain why I did this.

Uncle Sam, generally, may need to be paid before money is distributed to heirs. I am not providing you specific tax advice, nor am I providing you legal advice. However, I am sharing what I have learned via education and experience because this is something that a lot of people do not know and mistakes can be painfully expensive.

Cancelled debt, can trigger taxable income, which can result in an expensive IRS tax bill.

For example, one client received a 1099-C for student debt that was cancelled after the death of a family member. This triggered a large tax bill because of information shared earlier; i.e. a $600 exemption and a 39.6% tax rate. Exceptions, such as bankruptcy or insolvency, were not options.

Fortunately, recent tax reform changed this rule effective January 1, 2018:

Discharged of Student Loan Indebtedness

“The exclusion from income resulting from the discharge of student loan debt is expanded to include discharges resulting from death or disability of the student.”

A 1099-C may be issued for other forgiven deceased debt, such as credit card debt. Be prudent, and know your federal and applicable state rules before distributing assets to heirs. Your attorney may be a good resource to help guide you through this process.

 

3.  Form 706: Estate Tax Return

This form is used to report the transfer of assets from a decedent at the time of death.

The government imposes federal estate tax on the decedent’s entire estate. It is an excise tax on the right to pass property at death.

The Gross Estate includes the total value of the decedent’s interest in all property owned as of the date of death which can transferred due to the will or law. The form includes a number of schedules on which the estate lists the various assets or includes the expenses.

The theory behind the transfer tax system is to tax the value bequeathed to heirs. Since certain debts need to be paid and funeral expenses are customary, these amounts never become part of the inheritance. Because of this, the estate accounts for expenditures and debts in addition to assets.

Form 706 is due exactly nine (9) months after the date of death, unless the IRS has granted an automatic six (6) month extension of time.

For decedents who died in 2017, the executor of the Estate of every U.S. citizen or resident, files Form 706 for those:

  • Whose Gross Estate, plus adjusted taxable gifts and specific exemption is more than $5,490,000; or,
  • Whose executor elects to transfer the DSUE (Deceased Spousal Unused Exclusion) amount to the surviving spouse, regardless of the size of the decedent’s gross estate

Recent Tax Reform, the #TCJA, doubled the Estate Tax and Gift Tax Exemption, for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026. The exemption increased to $11,180,000 for 2018.

 

Non-Resident Filing Requirements

Use Form 706-NA, to compute estate and generation- skipping transfer tax liability for nonresident alien decedents. If an individual who is a nonresident alien has a gross estate of property located in the United States in excess of $60,000, an estate return is required.

 

In closing, Ben Franklin is often credited for saying: “Tell me and I’ll forget. Teach me & I may remember. Involve me & I learn.”  I write because it is one more way I can help others from getting hurt financially.

I hope this blog helped you learn a little  about death and taxes. The information provided was written to provide a broad perspective; individual facts and circumstances need to be reviewed to determine what, if any, tax returns may apply for you (or for those that you love).

If I can answer questions or help you, please let me know.

 

Thanks for reading,

Deb

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.

She offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.

https://www.DeborahFoxCPA.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

The blog is provided as general information only and should not be considered a substitute for specific advice and services of a Certified Public Accountant, Enrolled Agent, or an Attorney

Employee Owners and Accountable Plans

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A famous quote by Robert A. Heinlein is “When one teachestwo learn.”

In my experience, with almost every tax return I prepare or tax class I teach, I learn new ways to help others -financially. The missed opportunity for one can become Teachable Moments for others.

Single Member LLC- Transition from Schedule C to S-Corp:

Seasoned Sole Proprietors know they have a variety of “ordinary and necessary” business tax deductions available to them. These may be used long enough that they may just seem “normal” and like something that everyone getsall the time.

The Sole Proprietor may been rolling along, doing great, reached a certain level of net income and decided to change their tax filing classification from a Sole Proprietor to an S-Corp. They file form 2553, receive IRS approval, determine “reasonable compensation” and set up payroll for the Employee Owner.

Let’s pretend the above occurred in 2017 and in 2018 they asked me to help them with their 1st S-Corp tax return (1120S) and with their personal Form 1040 because the K-1 and other rules were new to them. I accept.

When preparing tax returns, it is always a good idea to compare the previous years returns with the current tax return because it helps to identify any significant changes. During this process, I identified 2 deductions used in 2016 that we could not use, retroactively for the 2017 return. For clarification, I am using the term “retroactively” because the 2017 tax year was closed, the W2’s issued, and we were now in 2018. They two (2) deductions identified were:

  • Self Employed Health Deduction
  • Home Office Deduction

 

New Tax Classification = New Tax Rules

A SMLLC, filing their IRS Form 1040 & Schedule C as a Sole Proprietor /Disregarded Entity wears one (1) “Taxpayer Hat” – their own

S Corporation Shareholder-Employees wear 2 “Taxpayer Hats”

  1. Employee who receives a W2 for their reasonable compensation earned during the year
  2. Shareholder/Owner may receive distributions from earnings and profits

Most of us know that we cannot co-mingle business and personal funds- they need to be separate.

  • The Schedule C taxpayer can use a business check to pay for a business flight for her business travel
  • The Employee Shareholder taxpayer needs to use a new process to obtain reimbursement for business travel

I understand this may sound strange, particularly if you are the only shareholder- “it is only me and it is all my money”. The IRS does not look at it like this- let’s use Starbucks as an example. Can a Starbucks employee write a business check to pay for their personal business expense? Usually – they cannot.

Employee Owners can use Accountable Plans to reimburse their allowable personal business expenses such as mileage, travel and meals. In my story, this was not an option for 2017 because the W2’s were already issued. However, this can be set up and used in the 2018 tax year.

  • S Corp Employee Owners must prepare expense reports and submit them to your Employer (company) on a regular basis
  • The S-Corporation issues a business check for the expense reimbursement which can then be deposited in the Employee-Shareholders personal account

My last blog, ‘Tax Reform and Employee Business Expense’, provided information and rules for Accountable Plans. Here are specific tips for the S-Corp Shareholder Employee:

Self-Employed Health Insurance Premiums:

One of the perks of being self-employed is that you can deduct the cost of health insurance premiums as an “Above the Line” deduction (Form 1040, Line 27).

“Above the Line” deductions are preferable because they can apply to everyone and are separate from choosing either to use the Standard Deduction or to Itemize Deductions.

To take this deduction, one of the following statements must be true:

  • You were self-employed and had a net profit for the year reported on Schedule C, C-EZ, or F. (Others may qualify too; the focus of this blog is the change from a Schedule C to an S-Corp)
  • You received wages in 2017 from an S corporation in which you were a more-than-2% shareholder. Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2
  • The insurance plan must be established under your business. Your personal services must have been a material in- come-producing factor in the business. If you are filing Schedule C, C-EZ, or F, the policy can be either in your name or in the name of the business
  • If you are a more-than-2% shareholder in an S corporation, the policy can be either in your name or in the name of the S corporation. You can either pay the premiums yourself or the S corporation can pay them and report them as wages. If the policy is in your name and you pay the premiums yourself, the S corporation must reimburse you. You can deduct the premiums only if the S corporation reports the premiums paid or reimbursed as wages in box 1 of your Form W-2 in 2017 and you also report the premium payments or reimbursements as wages on Form 1040, line 7

If the health insurance deduction cannot be used “Above the Line”, it is reported “Below the Line” on Schedule A, Itemized Deductions, as a medical expense, subject to the 7.5% of Adjusted Gross Income (AGI) limitation.

Home Office Deduction- for the convenience of the employer

  • S corporations may be able to use an Accountable Plan to reimburse expenses for the legitimate business use of the home. By doing so, the business can claim a deduction for necessary business expenses, while the taxpayer is allowed to exclude the reimbursements from income
  • Discuss your specific situation with your CPA or EA

This blog was written to help Small Business Owners know that there are many aspects to choosing a tax classification. It is so much more than “checking the box” or submitting the form.  If you want to learn more, reach out and schedule an appointment with your favorite Tax Professional. They, like me, love to help others save money through legitimate and timely deductions and/or tax planning.

In closing, if you are considering changing your IRS tax classification, I suggest you proceed with “informed caution”. Why? Generally, once an LLC has elected to change its classification, it cannot elect again to change its classification during the 60 months after the effective date of the election. Make sure you want to be “married that long” before you tie the knot and sign on the…dot. (Doted line)

Thanks for reading.

To your success,

Deb

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.

She offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of phone, virtual, and in-person communications.

https://www.DeborahFoxCPA.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

The blog is provided as general information only and should not be considered a substitute for specific advice and services of an Attorney, Certified Public Accountant or Enrolled Agent.

4 Step Process – What “Business Entity”?

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Tax and, to a lesser extent, Personal Liability, concerns often create a maze of confusion for those trying to decide what business entity should I choose?

I hope this blog reduces or resolves any confusion, creates clarity, and provides a solution for you.

This blog is intended to provide you a good “Birds Eye View” of your options and a systematic and analytical process to help you discover:

  • What “Business Entity” you may want
  • Why you want it, and
  • How much it will cost

As someone with both an accounting/tax and risk management background, I look at choices from two perspectives:

  1. The number side of me wants to find out if there is a way to save money.
  2. The risk management part of me wants to make sure we are protecting the money we have.

I also look at the “Cost VS Benefit” or the Risk/Return for decision alternatives.

Is the money spent worth the benefit received?

 This same process can work for you as you evaluate the pros and cons of your alternatives.

Before we look at the 4 Steps, it is helpful to see the “big picture” before diving into the details. “First, see the forest, and then see the trees”

Choosing a “Business Entity” involves choosing both a legal entity and also choosing the way you want your business entity to be taxed.

  • Legal Entities are created by state statues
  • Tax Classifications are created by the IRS

Legal Entities:

  • Sole Proprietor
  • General Partnership
  • Corporation
  • Limited Liability Company
  • Limited Partnership
  • Limited Liability Partnership

IRS Federal Tax Classifications are:

  • Sole Proprietor
  • Partnership
  • C Corporation
  • S Corporation

A cursory review of the two (2) lists clearly shows a mismatch; i.e. they are not “apples to apples”.

Hopefully, showing this to you “up front” will help you develop a discerning eye for the difference in terminology. Examples:

  • Corporations and Limited Liability Company’s are legal entities and not tax classifications.
  • A corporation has two tax classifications available to it, the C Corporation and S Corporation.
  • The Corporation is the legal entity and the C Corporation and the S Corporation are tax classifications.

If you get confused as you read through the details below, come back to the two lists to see which term fits where.

 Now, Back to the

Systematic and Analytical Process to Help You Decide:

  • What “Business Entity” you may want
  • Why you want it, and
  • How much it will cost

4 Step Process

  1. Take a Personal Inventory of your Business Needs
  2. Research & Understand your options
  3. Review the Cost VS Benefit of your possible choices
  4. Meet with a Certified Public Accountant (CPA) and an Attorney to help you finalize your decision

Factors to consider in your decision may include:

  • Your Objective
  • Your Industry
  • Short and Long term goals
  • Tax Implications
  • State law treatment
  • Protection for Personal Assets
  • Formation cost
  • Recordkeeping and ongoing maintenance requirements
  • Capitalization
  • Compensation
  • Allocation of Profits, Losses, and Distributions
  • Fringe Benefits
  • Rights and Duties of Business Owners
  • Management and Control
  • Transfer, Conversion, and Merger
  • Termination/Dissolution

Step 1:

Personal Inventory of your Business Needs:

  • What Do I have to Protect?
  • Liability exposure from your product, services, or location?
  • Am I operating this business by myself or do I have partners, shareholders or members?
  • What are my short and long- term goals?
  • Do I want to retain capital to pay for inventory or to fund growth?
  • Do I want to raise capital?
  • Do I want to establish business credit?

 

Step 2:

Research & Understand Your Options:

Broad Perspective:

Taxes and Personal Liability should both be considered as primary factors in your decision.

  • This blog will focus upon federal taxes; your state statues should also be reviewed. Don’t assume that your state law will follow the IRS. Do the research.
  • Personal Liability and the protection of personal assets, will be addressed within each entity type

The two types of federal taxation that are often considered in entity selection are income tax and self-employment tax.

Income Tax obligations vary depending on the legal structure and tax classification.

The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation.

A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute; it is not an IRS filing status.

  • With pass-through taxation, generally, no income taxes are paid at the business level. Business profit or loss is passed-through to the owners’ personal tax returns.
  • Corporations, on the other hand, are separate tax entities and are taxed independently from owners.

 

Self-Employment tax is required if your annual net earnings is more than $400.

As an employee, you know that money is withheld from your paycheck for social security and Medicare tax; you and your employer split this 50/50.

Self-Employed individuals must pay both the employer and the employee side of Social Security and Medicare tax.

The self-employment tax rate for 2017 is 15.3% of the first $ 127,200 of income and 2.9% of everything above that amount.

There is an income cap for the Social Security tax; the Medicare tax is not capped.

The Social Security tax rate is 12.4%; the Medicare tax is 2.9% (15.3% combined).

  • Self-Employment taxes are reported on Federal Form Schedule SE
  • Taxpayers can deduct 50% of their self-employment tax in determining their Adjusted Gross Income on Form 1040; the adjustment does not affect the amount of self-employment tax owed.

 

Detail Perspective:

Sole Proprietor: Flying Solo

Sole Proprietorships are an unincorporated business that is owned by one person.

Owner Liability?

  • Unlimited; A Sole Proprietor is always personally liable for the debts, obligations, and liabilities of the business

How Are Income Taxes Paid? :

  • Report business income or losses on your personal income tax return; the business itself is not taxed separately. File form 1040 and use Schedule C- Profit or Loss from Business.

Will I pay Self Employment Tax? –

  • Yes; file Schedule SE with your federal form 1040

Other Entity options for a Single Owner Entity?

  • Corporation
  • Limited Liability Company- Single Member LLC

 

Partnership: Two or More:

A Partnership is a relationship formed by 2 or more persons or entities that join together to carry on a trade or business.

Two primary choices:

  1. General Partnership – By definition, at least 2 General Partners each of whom manage the partnership
  2. Limited Partnership – A Limited Partnership has 1 or more General Partners and 1 or more Limited Partners. The General Partner manages the partnership; Limited Partners are typically passive investors.

 

Owner Liability?

  • General Partners, in a Partnership, are “jointly and severally” liable for the debts, obligations, and liabilities of the business
  • Limited Partners, in a Limited Partnership, have limited liability unless they take an active role in management; General Partners remain personally liable

How Are Income Taxes Paid?

  • Partnerships file an annual information return; file federal form 1065 and Schedule K-1 is used for the individual member’s profit and loss; Individual Partners file their personal tax information on Federal Form 1040 and Schedule E, Supplemental Income and Loss

Will I pay Self-Employment Tax?

  • Yes, if general partner
  • Generally, No, if limited partner

 

C-Corporation:

A corporation is a separate legal entity with a life beyond that of its owner.

For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.

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

Owner Liability?

  • Corporations (C or S) – Shareholders are not personally liable for debts, obligations, or liabilities of the business

 

How are income taxes paid?

  • The C Corporation pays taxes on the annual net earnings and files federal form 1120

Will I pay Self-Employment Tax?

  • No, Self Employment Tax does not apply because payment for services is in the form of wages, which is subject to withholding for social security and Medicare tax

 

S-Corporation

  • An S corporation combines the limited liability of a C corporation with the tax treatment similar to a partnership.
  • You “elect” to become an S Corp by filing Form 2553 with the IRS within the 1st 75 days of the tax year that you want to operate as an S Corp.
  • The S status is only to elect to have all income /losses pass-through to the owners/stockholders and you must qualify to elect.
  • Failure to comply with IRS requirements will cause the S-Corp to lose its status.
  • State taxation of S-Corps vary – see your state rules. Some states treat S corporations, like C corporations, and impose an income or franchise tax.

 

Owner Liability?

  • S Corps limit liability to the same extent as C Corporations
  • Corporations (C or S) – Shareholders are not personally liable for debts, obligations, or liabilities of the business

How is Income Taxes Paid?

  • S Corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes
  • S Corporations are responsible for tax on certain built-in gains and passive income at the entity level
  • File S-Corp informational return on Federal Form 1120-S and use Schedule K-1 for the individual shareholder’s profit and loss
  • Shareholder-Employees are taxed on their salary income and on any profits distributed by the S-Corporation
  • Shareholder-Employees file Federal Form 1040 and Schedule E – Supplemental Income and Loss

 

Will I pay Self Employment tax?

  • Generally, no, this is why many Small Business Owners elect to be an S-Corp, if they qualify

 

Limited Liability Company (LLC)

State statues create a Limited Liability Company; owners are called members.

There are 2 primary types:

  • Single Member
  • Multi-Member

Owner Liability?

  • LLCs are state entities; the level of legal protection given to a company’s owners depends upon the rules of the state in which the LLC was formed

 

How are Income Taxes paid?

The tax classifications available to an LLC vary based on the number of members

  • All income, gain, loss, and deduction flow through to members unless the LLC is taxed as C-Corp
  • A Single Member LLC, by default, is a disregarded entity
  • A Single Member LLC can choose to be taxed as a “Corporation” *
  • A Multi Member LLC, by default is a Partnership
  • A Multi Member LLC can choose to be taxed as a “Corporation” *

 

Generally, when an LLC only has one member, the fact that it is an LLC, is ignored or “disregarded”, for the purpose of filing a federal tax return, and is treated the same as a Sole Proprietor.

 

If the only member is an individual, LLC income and expenses are reported on federal form 1040 and Schedule C, E, or F unless it files Form 8832 and elects to be treated as a C Corporation. *

 

A domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Federal Form 8832 and elects to be treated as a C Corporation *

An LLC can also elect to be an S Corporation, if they qualify*

The type of legal entity remains the same—only the tax classification changes to impact how the entity reports and pays taxes.

 

Will I pay Self Employment Tax?

  • Yes, Self-Employment Tax applies except if the LLC operates as C-Corp or S-Corp
  • Sole Proprietor and Partners both pay this tax. File Schedule SE with your federal form 1040

Step 3:

Determine the Cost VS The Benefit:

  • Each Option has it’s own “cost” and “benefit”. Understanding this helps you make an educated decision before you spend any money.
  • The options available to you vary by state and by profession. There is no one size fits all rule, for everyone, across the United States.
  • Visit your local SBDC, Service Corp of Retired Executives (SCORE), and Secretary of State website to find specifics for your area
  • Consider Tax (monetary) and Non-Tax benefits

Costs Include:

  • Filing Fees and Set-Up Costs
  • Annual Maintenance Fees & Services
  • Any State Entity Taxes on Gross or Net Income
  • Tax Return Preparation and Services through out the year
  • Cost, in terms of Time & Money: the amount of paperwork required, Board Meetings, Shareholder meetings, minutes, etc.,

For your state entity taxes, you could use an estimated amount of gross or net income for perhaps, 1, 3, and 5 years and then determine you estimated tax for each year. No, this is not a “real number”, but it does provide a useful illustration to help quantify your cost for alternatives

Benefits Include:

  • Potential Tax Savings
  • Peace of Mind because your personal assets are protected from business liability
  • Other intangibles 

 

Step 4: Meet with an Attorney/CPA to help finalize your choice:

Although a lot of information is included here, it does not cover everything that is important to understand.

Your preliminary research has probably increased your understanding, narrowed your choices, and also created new questions for you.

You could consider this 4 Step process as a good preliminary foundation for your discussions with your attorney and CPA; they can provide more details about income tax and legalities for your situation.

 

Wrapping Up

The entity selection process can seem like a maze of confusing options. I hope this information helped to remove some confusion and perhaps, make a small difference for you? If so, please let me know; I’d appreciate it. Thanks.

 

Thanks for reading.

To your success,

Deb

 

 

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. She is passionate about helping others. She teaches and also blogs to provide helpful information for individuals, independent contractors entrepreneurs, and small business owners.

Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of phone, e-mail, virtual, and in-person communications.

 

http://www.DeborahFoxCPA.com

 Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

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.

Can the IRS help you recover from Mother Nature?

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Mother Nature created a life changing financial effect upon many American financial lives.

  • Since 6/11/16, there have been 6 Major Disaster Declarations in 6 different states: Texas, Oklahoma, West Virginia, Montana, Wisconsin, and Louisiana
  • During the same period of time, there have been numerous Fire Management Assistance Declarations in multiple states, mostly in California and most recently in Washington

If I could, I would, restore your homes to their original condition- with a wave of a Faerie wand or a twitch of a nose. Unfortunately, I cannot do that.

What I can do is to use my commercial property & casualty experience and my tax knowledge, to create this blog and hopefully provide you information you can use, to help you recover from a financial loss.

Damage caused by Mother Nature = Casualty Loss:

A casualty loss can result from the damage, destruction, or loss of your property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption. It does not include normal wear and tear or progressive deterioration (termite damage).

  • For those that had a property loss due to fire, an insurance policy may have helped you recover some of your financial loss
  • For those that had a property loss due to a flood, financial help from an insurance company may not be  available; FEMA or others might help

 

In addition to insurance or FEMA assistance, the IRS tax rules may provide you some tax relief:

  1. Allow you to deduct a portion of your unreimbursed loss on your individual tax return
  2. Allow you to use a Net Operating Loss to change past tax returns or to use that loss on a future tax return

 

Perspective:

  • Casualty Losses are required to be reported on Schedule A as an Itemized Deduction
  • For practical purposes, Itemized Deductions need to be greater than the Standard Deduction to provide you a tax financial benefit
  • Is your loss more than the amounts shown below?

 

2016 Standard Deductions:

  • $6,300 for Single and for Married Filing Separate (same as 2015)
  • $12,600 Married Filing Joint (same as 2015)
  • $9,300 Head of Household (was $9,250 for 2015

 

Planning Tip: “Details create the big picture “ – Samuel I. Weill

  • The IRS requires documentation for tax deductions; start to gather and prepare now
  • The only way to see what will work for you is to gather, evaluate and decide
  • If you have questions, reach out and ask, including from me

 

Individual Tax Deduction Rules:

  • Generally, you may deduct casualty and theft losses relating to your home, household items, and vehicles on your federal income tax return
  • You may not deduct casualty and theft losses covered by insurance, unless you file a timely claim for reimbursement and you reduce the loss by the amount of any reimbursement or expected reimbursement

 

If your property is personal-use property or is not completely destroyed, the amount of your casualty loss is the lesser of:

  • The adjusted basis of your property, or
  • The decrease in fair market value of your property as a result of the casualty

 

If your property is business or income-producing property, such as rental property, and is completely destroyed, then the amount of your loss is your adjusted basis.

 

Tip: Adjusted Basis =

  • The adjusted basis of your property is usually your cost, increased or decreased by certain events such as improvements or depreciation
  • For property you buy, your basis is, generally, the cost to you
  • For property you acquire in some other way, such as inheriting it or getting it as a gift, you must figure your basis in another way- see Pub 551

 

Claiming the Loss:

  • Individuals are required to claim their casualty and theft losses as an Itemized Deduction Form 1040, Schedule A
  • For property held by you for personal use, you must subtract $100 from each casualty or theft event that occurred during the year after you have subtracted any salvage value and any insurance or other reimbursement
  • Then add up all those amounts and subtract 10% of your adjusted gross income from that total to calculate your allowable casualty and theft losses for the year
  • Consider using your 2015 Adjusted Gross Income (AGI) as a benchmark – (the last line, on the 1st page, of your 1040 tax return)
  • Report casualty and theft losses on Form 4684, Casualties and Thefts
  • Use Section A for personal-use property and Section B for business or income-producing property
  • If personal-use property was damaged, destroyed or stolen, you may wish to refer to Pub 584, Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property)
  • For losses involving business-use property, refer to Pub 584-B, Business Casualty, Disaster, and Theft Loss Workbook
  • These workbooks are helpful in claiming the losses on Form 4684; keep them with your tax records

 

When to Deduct:

  • Casualty losses are generally deductible in the year the casualty occurred
  • However, if you have a casualty loss from a federally declared disaster that occurred in an area warranting public or individual assistance (or both), you can choose to treat the casualty loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year
  • Claiming a disaster loss on the prior year’s return may result in a lower tax for that year, often producing a refund – Do the Math

 

When Your Loss Deduction Exceeds Your Income

  • If your loss deduction is more than your income, you may have a Net Operating Loss (NOL)
  • You do not have to be in business to have an NOL from a casualty
  • For more information, refer to Pub 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts

 

Net Operating Loss (NOL)– Individuals:

  • Net Operating Losses occur when you have more tax deductions than you have taxable income
  • You may have a NOL if you have a negative number on the line for taxable income before you deduct your personal exemptions- Form 1040, Line 41
  • This can occur in you have a large casualty loss, such as a flood or a fire, and are not reimbursed for the loss from insurance or other possible sources

 

If you have a NOL:

  • Decide whether to carry the NOL back to a past year or to waive the Carry Back period and instead carry the NOL forward to a future year
  • NOL year= This is the year in which the NOL occurred
  • Generally, if you have an NOL for a tax year ending in 2015, you must carry back the entire amount of the NOL to the 2 tax years before the NOL year (the Carry Back period), and
  • Then Carry Forward any remaining NOL for up to 20 years after the NOL year (the Carry Forward period)
  • You can, however, choose not to Carry Back an NOL and only Carry it Forward
  • See IRS Publication 536

 

I realize this is a lot of information to take in at one time. Keep it as a guide, and take one step at a time. The following action steps will help you get started.

 

Action Steps:

  • Inventory your loss by property type- real property (real estate); personal property; automobiles; business property
  • If you own real estate, determine your cost basis
  • If you need to replace IRS information, use their “Get Transcript” tools, for wage/income information and to obtain previous tax returns
  • State tax rules are different; research yours when you can, to see if tax benefits are available there
  • When you can:
  1. Quantify the value of items lost
  2. Quantify the money received to replace part of your loss
  3. Find your initial IRS loss number: Value of items lost – money received = unreimbursed loss
  4. Use the Unreimbursed loss number to see if the IRS rules, included above, can help you recover, at least some, financially
  5. If you have questions, feel free to contact me via e-mail or by phone; if you use e-mail, please do not send attachments or any personal financial information- that information should always be protected. General questions and specific numbers are safe.

 

“In times of turbulence and change, it is more true, than ever, that knowledge is power ” – John F Kennedy

“Tax Filing is mandatory; Tax Planning is optional; Tax Planning & Acting can help you keep more $$ in your pocket rather than Theirs (The IRS)” – Deb Fox

It’s impossible said Pride; It’s risky said experience; It’s pointless said reason; Give it a try whispered heart” – anonymous

 

Thanks for reading,

Deb

 

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth. She can help by being your financial compass while you captain your ship.

Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.

http://www.debfoxfinancial.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

Does the IRS think you have a Business?

2013 Tax

Many taxpayers started a business and thought, or were told, “Don’t worry about the expense, it’s a write off on your tax return”.

The truth is that this may or may not be true.

Tax is not a cookie-cutter industry and as you can probably guess, the IRS did not make a “One Size Fits All” tax rule for write-offs.

If your intent is to enjoy your hobby and perhaps make some incidental income, this blog may not be of interest to you.

If your intent is to make money through a legitimate business, as defined by the IRS – this is for you

  • My purpose is to provide you “heads up” and “eyes open” to help ensure your business and financial success
  • This blog is provided to help educate you on how to organize, manage and conduct your business to improve your chances with the IRS in the event that your “activity” is audited ***

 

IRS Hobby VS Business Rules:

  • An “Activity” is either a hobby or a business
  • The IRS uses facts to decide if an activity is a (hobby) or a business
  • Neither the Code nor the Regulations provide an absolute definition
  • It is difficult for a taxpayer to win a hobby-loss case at the Tax Court level
  • If your tax return pays tax as a business and the IRS finds that it is a hobby, your tax return can be corrected and your tax liability could go up; i.e. you might owe the IRS money ***
  • The financial adjustment may be significant. In addition to the loss of the deductions, you, may face a §6662 understatement penalty for the tax years in question ***

 

Hobby Rules:

  • An activity is presumed to be a Hobby if a profit is not earned in at least 3 taxable years of a consecutive 5-year period
  • A taxpayer can overcome the presumption if he/she can show the activity was operated with a For-Profit motive
  • Under IRC §183, a taxpayer’s deduction for Hobby losses is limited to the income produced
  • You must itemize deductions to claim hobby expenses on your tax return
  • Hobby expenses, along with other miscellaneous expenses you itemize on Schedule A, must come to more than 2% of your adjusted gross income before you can deduct them
  • Hobby Expenses can bring your Hobby Gross Income, to zero
  • Income is reported on your IRS Form 1040, Line 21, Other Income
  • I understand that this can be confusing, so I will rephrase differently, to help bring clarity:
  • Hobby Income needs to be reported
  • Hobby Expense deductions have 3 limitations:
  1. Total Itemized Deductions have to be greater than your Standard Deduction
  2. Hobby expense deductions are limited to the hobby income produced, and then
  3. Then those expenses must be reduced by 2% of your Adjusted Gross Income (AGI)

 

Business Rules:

  • A Business has a For-Profit motive
  • A simple, general rule is that if the business makes a profit in 3 of 5 years there will be a presumption of profit
  • IRC § 183(d) is a safe harbor for the taxpayer
  • If the business is For-Profit, no limit on deductions is imposed and the taxpayer may be able to use losses to offset (reduce) other taxable income
  • If an activity has not produced profits in three of the past five years, the taxpayer may still argue that the business has a profit motive by relying on Reg. §1.183-2, which provides for a nine-factor test
  • More weight is given by the courts to the objective facts (rather than to the taxpayer’s statement intent) Dreicer v. Comr., 78 T.C. 642 (1982)
  • Judicial decisions suggest that no one factor is controlling
  • Court decisions often seem to consistently rely on the first factor as the most important

 

The prevailing regulations list nine critical factors for determining whether an activity constitutes a Hobby or a Business. They are:

  1. The manner in which the taxpayer carries on the activity
  2. The expertise of the taxpayer or his or her advisers
  3. The time and effort expended by the taxpayer in carrying on the activity
  4. The expectation that assets used in the activity may appreciate in value
  5. The success of the taxpayer in carrying on other similar or dissimilar activities
  6. The taxpayer’s history of income or losses with respect to the activity
  7. The amount of occasional profits, if any, which are earned by the taxpayer
  8. The financial status of the taxpayer
  9. Any elements of personal pleasure or recreation

 

Business Tax Reporting:

  • A Sole Proprietor or Qualified Joint Venture will file a federal return on Form 1040 and Schedule C- Profit or Loss from Business
  • If you have another Schedule C business activity; a separate Schedule C is required for each business; the same is true for your business records
  • Check to see what tax reporting is required by your state tax board and local municipality
  • The IRS expects you to pay tax as the money is earned
  • If you operate on a calendar year, due dates are 4/15, 6/15, 9/15, and 1/15 for the previous year
  • Quarterly estimated tax payments should be paid if you expect to owe more than $1,000 in federal taxes on an annual basis
  • Use 1040ES for Individual Estimated Payments
  • Reconcile payments on your annual Year End tax return
  • Self-Employment tax of 15.30% is required on all Annual Net Earnings of more than $400

 

Building the Foundation for a For-Profit Business Intent

Tips for Success:

  • Conduct your business, like a business, consistently
  • Consistency includes Quarterly tax reporting and payments – as required
  • Quarterly reporting requires that your accounting records be current – so you know if you have a profit or a loss
  • Taxpayers bear the burden of proving that they engaged in the activity with an actual and honest objective of realizing a profit
  • Keep detailed financial records
  • Credit Card and Bank statements and cancelled checks are not enough- the IRS needs to see the detail of what you bought
  • Receipts are your Audit Protection – the IRS has Strict Substantiation Requirements
  • The Cohen Rule,” states that you can use “other credible evidence,” or rely on IRS Publication 463 which states that you don’t need to keep receipts for expenses under $75 – it is safer to save all receipts and to follow a consistent business practice
  • Don’t use Cash: it is hard to track, easy to spend and nearly impossible to reconcile with receipts
  • Establish separate checking and credit accounts for your business – don’t co-mingle business & personal funds
  • Keep a Time/Activity Log- Outlook or Google calendar may be requested during an audit
  • If you have had business losses and made changes in the attempt to improve profitability, keep a list of changes made and the date the change was made
  • Establish a level of expertise by attending seminars, networking, and joining professional organizations related to the activity
  • Anticipate that you could be audited ***
  • Pursue your passion, enjoy the journey, and ask questions as you learn along the way

 

If you want to learn more about IRS tax rules, contact for me for a $75.00 Special: includes a 45 minute Q&A phone session plus a free “cheat sheet” for your personal use. The “cheat sheet” includes accounting/tax tips about what is a deductible expense, etc. Offer is valid until 9/5/16.

 

“Success is nothing more than a few simple disciplines practiced every day” – Jim Rohn

“To open a shop is easy; to keep it open is an art” –Chinese Proverb

 

Thanks for reading,

Deb

 

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth. She can help by being your financial compass while you captain your ship.

Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.

http://www.debfoxfinancial.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

Is Your Tax Situation Causing You Pain?

 

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Perhaps, a little humor can help the “medicine go down”

Is a Tax problem (and pain) keeping you up at night? If so, I hope to provide you some relief to feel better by:

  • Helping you Identify your status & gain perspective
  • Provide education – process, proposed solutions, and
  • Suggest do’s and don’t to remedy your situation, or
  • Identify those that can legally help you and with what

Pain Scale:

0 – I hope it stays this way – always

Mild Pain – Filed an extension & still not ready to file?

1-2 – Mild Pain – Can be Ignored?

Moderate Pain – Audit – Find your Records?

3 or 4: Interferes with Tasks

5 or 6: Interferes with Concentration

Severe Pain – Assets seized? Wage Garnishment?

7 or 8: Interferes with Basic Needs

9 or 10: Bed Rest Required

Regardless of your situation, know that you are not alone and help is available.

Tips for those with a Mild diagnosis

  • You have until 10/17/16 to file your 2015 return
  • Now is the time to request help if you want it
  • Reminder to stay current with your estimated tax payments for 2016

Tips for those with a Moderate/Severe diagnosis

Remind yourself that being afraid of things going wrong isn’t the way to make things go right.

Fear is interest paid on a debt you may not owe” – anonymous

Take a breath and let’s dig deeper.

There are 3 types of IRS Audits (verified compliance)

  • Correspondence Exam– not Face to Face
  • Office – Local IRS office – Desk Audit
  • Field – Your office or home or your Accountants office

Audit Scope/Complexity varies from low to high risk

  • In a Correspondence Audit, the IRS, generally, will not expand the scope
  • If you request a transfer to an Office Audit, because of complexity or large amount of documents, the Revenue Agent has the authority to Expand the Scope- IRS internal approval required
  • Field Audit scope can be expanded without approval 

An Audit LifecycleSimplified

  • Inquiry
  • Provide info
  • Wait
  • Proposed Changes
  • Wait
  • Provide Additional info
  • Finalize

Timeframe to Resolve (perspective)

  • Correspondence Exam – 3 to 6 months
  • Office Exam – can take over a year

 

What you need to know:

  • A discrepancy is not an audit; i.e. Form CP 2000, but should be treated like an audit
  • For Audits, the Burden of Proof, falls upon the Taxpayer- show why you are entitled to deduction
  • The IRS may give you a Proposed Tax Bill if you don’t substantiate your position
  • Your Tax Adviser can help you by being the Auditor before the Audit; examples:
  1. Can help you identify Audit Risks – problem areas on your return and/or overlooked deductions & credits
  2. Poor Books & Records & the need to recreate

 

Dos and Don’ts

Do:

  • If you handle your own IRS correspondence, Be Clear, Concise, and To The Point
  • Do provide credible evidence
  • Be timely in your response and provide the requested information – Be organized and help them do their job
  • Do know the Limits on Representation:
  1. CPA, EA, & Attorney can help through the Appeals process
  2. Attorney only for Tax Court

 

Don’t:

  • Do not include needless facts- the auditor could miss your main point if you ramble
  • Do not send/bring a big box of loose unorganized paper- this sets your audit off on the wrong foot
  • Don’t ignore their letters

Action Steps:

  • Read what the IRS is looking for
  • Gather documents, organize, & summarize
  • Recreate unavailable documents
  • Decide, am I going to do this alone or get help

 

Process:

Audit Determination:

  • No change
  • Agree with changes – make payment arrangements
  • Disagree with changes – Appeals Mediation or Appeal

Collection:

  • Generally, the IRS will send you a written notice requesting that you pay a specific amount
  • If not paid and you do not contact them, the IRS could force you to pay by taking future refunds, placing liens on your property, seizing assets, & garnishing your wages

Installment Agreement:

  • Signed agreement to pay down the debt over a period of time
  • Can prevent Wage Garnishment IF payments are made on time

Offer in Compromise:

  • An agreement to settle the debt for less than the amount owed
  • You must qualify by meeting compliance and eligibility requirements. Requirements are strict and the IRS only accepts this under limited conditions

Appeals Mediation:

  • Alternative Dispute Resolution
  • Helps to develop resolution strategies
  • Appeals mediator has no power to render a decision or to force either party to accept a settlement.

Appeal:

Appeals is the place for you if ALL of the following apply:

  • You received a letter from the IRS explaining your right to appeal the IRS’s decision.
  • You do not agree with the IRS’s decision.
  • You are not signing an agreement form sent to you.

 

Closing Comments:

  • This blog is intended to provide you some insight and helpful solutions. It is not exhaustive of all possibilities
  • 1st Time Abatement Penalty and relief from other penalties were not discussed in this blog

 

If you have questions, feel free to call me at 619-549-2717.

“They always say time changes things, but you actually have to change them yourself “ – Andy Warhol

 

Thanks for reading,

Deb

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth. She can help by being your financial compass while you captain your ship.

Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.

http://www.debfoxfinancial.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

5 Ways a CPA can help Small Business

 

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Small Business Owners, particularly in the early stages, are doing it all.

Sometimes it can feel like an up hill battle. There is so much to do, and learn, and not enough time to do it. Financial resources can be scarce and stretched thin.

Sometimes spending a little can help you a lot. The value is apparent.

What We Do:

CPA’s do much more than crunch numbers and report on facts that have already happened in your financial statements.

CPA’s provide advice. We educate our clients and help them improve their financial business results.

Our value can often be quantified, measured, seen and/or felt by business owners.

CPA’s provide a wide variety of services.

I enjoy helping small business owners with income tax and with all the detail that includes. I understand almost no one likes tax; however, we all like to save money. For me, using IRS rules to help others is fun.

How We Help:

1.  A CPA  can help prevent “Blind Spots”:

What you don’t know can hurt you. I’m not telling you this to scare you. Rather, to educate you and provide an objective example.

Many new Small Business Owners do not know that the IRS expects them to pay tax as the money is earned and that quarterly reporting and payments are required if you expect to owe more than $1,000 annual tax to the IRS.

This means that you need to keep your accounting records current so you can determine if you need to begin quarterly reporting and payments. 

2.  A CPA can help with your Budget:

  • Self-Employment tax of 15.30% is required on all Annual Net Earnings of more than $400
  • The 2015 SE tax rate on Net Earnings is 15.3: (12.4% social security tax and 2.9% Medicare tax)
  • Do you include this expense in your budget so you have cash when it is time to pay the IRS?

 

3.  A CPA can help you make Decisions:

  • Data (information) can be used to help you make cost effective decisions
  • Review Forecasted to Actual Financial results – what happened?
  • Help a business owner interpret the financial statements and offer suggestions to improve profitability, cash flow, and efficiency

 

4.  A CPA can help you Minimize your Income Tax:

  • Do you know what you can legally deduct on your tax return?
  • Do you know how to use strategy to reduce your business tax bill?
  • Tax Planning includes education, evaluation, and action

 

5.  CPA can help you improve Profitability:

  • When I told an architect that they were required to pay Self-Employment tax, they were shocked. They told me, I have to raise my prices immediately. I am not making any money.
  • We can help you determine if your pricing is profitable or if you are working for free or for not as much money as you thought you were making
  • You don’t want to wait until year-end to find out
  • As we all know, time is money and the faster we can earn it and build a financial cushion, the more comfortable we feel

 

You have 3 choices:

  1. Do it yourself – inexpensive, but can be costly
  2. Do it for me – expensive & might be seen as a luxury until the cash starts coming in – consistently
  3. Do Some of it for me: a cost effective bridge to obtain education and help on a “as needed” basis

 

Thanks for reading,

Deb

Call me about an Accounting & Tax Tip Cheatsheet  619-549-2717

 

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth. She can help by being your financial compass while you captain your ship.

Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.

http://www.debfoxfinancial.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA