Tax Planning

Change is a constant part of life. With each change, adjustments have to be made. Certain changes in our lives puts us in a different tax category or changes how we need to file our taxes. Legally, we may come under different rules and requirements. There are tax advantages or credits that come with some of life's changes. Below are a few events that can take place in your life where you may need some professional guidance with the filing of your taxes.

Getting Married

As a single person, you filed your taxes as a single individual. Now that you are getting married, will it be cheaper to file a joint tax return or separate tax returns? One spouse may own a business or may quit their job. Are there children involved? A CPA can take all of your circumstances into account. Then they can help you set up your tax returns and finances for your best advantage.

Newborn Baby

The tax laws allow exemptions when you have a new baby. You will be able to take advantage of certain tax breaks. A CPA can help you understand which exemptions you qualify for and keep you up to date on current laws.

Adoption of a Child

When adopting a child, there are tax credit allowances available. An employer can offer financial assistance to help pay for the adoption, but tax-free assistance is limited. A CPA can educate you on what tax advantages are available for you given your circumstances and how much tax-free assistance you can receive. For example, both federal and state tax laws also allow for some benefits when prepaying for your child's college education.

Death of a Spouse

With the death of your spouse, there will be questions about inheritance taxes and social security benefits to be answered. How much, if any, will you owe in federal estate taxes or state death taxes? Do you qualify to receive any of your spouse's social security benefits? You may also need help in filing your spouse's income taxes for the amount of time they worked during the year.

Divorce

Many tax related situations will arise due to a divorce. Alimony, child support, splitting of assets and tax returns will all have to be handled. What about property taxes and how the transfer of property may be taxed? Professional guidance will make the process less confusing and easier to navigate.

Legal Separation

Similar to being divorced, being legally separated has its own tax implications. Should you still file jointly or should you file as a single taxpayer? What is required if the children are staying with you or if they are living with your spouse? Other than federal laws, what are the laws in the state in which you live?

When Paying and Receiving Child Support

Paying child support can be a burden on your income, but certain tax deductions may be allowed. Is the recipient of the child support required to pay income tax on the amount paid to them? A CPA can make sure you are filling out your taxes correctly.

Sudden Disability or Accident

If you have an accident and suddenly become disabled, you may have access to some type of disability insurance. Should you count your insurance payments as income? What part, if any, is taxable?

Diagnosis of Long-term Illness

Elderly people often face chronic health issues that may one day take their life. They look for ways and individuals to protect their financial interests. Sadly, many elderly people are victims of financial abuse. A trusted CPA can be a great partner to protect their financial interest and safeguard them from someone taking advantage of them.

Selling or Buying a House

If you itemize, many of the expenses of buying a home and paying a mortgage can be tax deductible. If you sell your home, the government requires you to pay capital gains tax. What is deductible and what amount you will have to pay capital gains tax on is what you and your CPA will have to figure out. In addition, energy-efficient upgrades or the installation of medical home improvements may qualify for tax credits.

Moving to a Different State

If you move to a different state, you will most likely have to fill out tax returns for each state. Income taxes are figured differently in each state. Some states do not require its citizens to pay income tax. Other states have flat rates or taxes are based on your income bracket.

Starting a Business

Depending on the type of business and how many employees you have, you must make sure your accounting practices comply with what the government requires. Certain expenses can be tax deductible and you will need a feasible procedure to keep up with them. In addition, personal and business expenses need to be kept separate. Business taxes are filed on a different form, for starters. Business losses could affect how much you have to pay on income from other sources. Business owners are also allowed to depreciate equipment and buildings that deducts from the taxes they owe. Also, if you work from home, or your home serves as the headquarters for your business, tax laws allow you certain deductions.

You Inherited a Large Amount of Cash or Property

Inheritance taxes can be very costly. Knowing the specifics can save you a lot of money. Making investments with the money could save on paying taxes for the present. Knowing how to categorize inherited property will help in using them as a tax deduction.

Retirement

Retiring changes your tax situation. Social security payments and pensions need to be counted as income. You will need to determine what tax bracket your total combined income puts you in. IRA regulations require a certain amount to be pulled out when you reach a particular age. Some IRA withdrawals are taxable. New tax laws for retirees may change how you fill out your taxes.

If any of the above events happen in your life, visiting a CPA can save you a lot of money and help you meet your new legal requirements. Your CPA will understand how your particular situation and circumstances may qualify you for certain tax breaks and advantages.

Two of the biggest concerns of those who are investing for retirement are not running out of money and maintaining regular cash flow. It can be difficult to switch from a bi-weekly paycheck to carefully timed withdrawals from a retirement account.  Market fluctuations cause balances to rise and fall, leaving an investor with less in their account than they’d planned. 

These are the reasons that some investors consider real estate investments for retirement. A multi-family property yields regular, monthly income similar to a paycheck. Home values typically don’t fluctuate wildly and over time show appreciation. But what are the deeper implications of real estate investing for retirement?

Pros of Real Estate Investing for Retirement

Five thousand dollars in rent, deposited into your bank account every month, can easily take a salary’s place. One of the biggest pluses to real estate investing for retirement is passive income. Tenants pay monthly rents and you can use that income to fund your retirement.

If you can’t afford to pay cash for your investments, you’ll have a monthly mortgage payment. But, depending on your down payment, it could be quite small.  Protecting your cash reserves is important in retirement, so if you’re not fully comfortable purchasing properties directly, look into real estate investment trusts, or REITs.

Before deciding to invest through a REIT or partnership, talk to a Registered Investment Advisor or RIA with deep knowledge of real estate investing. They can outline the risks and rewards of each type of indirect real estate investment available to you, and guide you to one that fits your needs.

With a real estate investment, you’ll have more control over its appreciation. Stock prices rise and fall for reasons entirely out of your control. If a CEO makes a poor investment or an acquisition falls through and your portfolio loses so much value that you have to touch principal that quarter. But with a property, you have more control.

Make improvements to the structure, or add some landscaping or a new roof, and your property’s value rises.  If you have creditworthy tenants who pay on time and schedule regular rent increases to keep pace with inflation, your property will continue to appreciate in value.

You can also decide on when to sell if home values rise sharply in your area and you want to cash in the equity. If you pick the tenants, you control the people living in your building. And you decide how much of your retirement funds you want to put into property and how much you invest elsewhere.

Diversifying your retirement portfolio protects you against stock market crashes or economic downturns. After you’ve put money away in a 401K, then what? Adding real estate to your retirement plans helps diversify your portfolio and hedge against risk.

Cons of Real Estate Investing for Retirement

Properties have to be managed. From collecting rents to managing tenants to snow removal, a real estate investment isn’t one that is maintenance-free.  In a way, building a retirement portfolio around real estate investments ensures that you’ll never actually retire.

A way around this is to hire a property management company. A property manager handles the administrative duties of properties. They collect the rent, they arrange for repairs, and they contract for lawn care and snow removal. But not all property managers offer the same level of service.

You will have to interview prospective management companies, and check references.  And since it’s not a great idea to be a completely hands-off landlord, you’ll have to monitor the property manager’s performance and periodically review their service. This means that, in the midst of your golden years, you could be firing and hiring a new company.

Property manager fees range from 2—5% of the monthly rents or they charge per-unit.  When putting together a retirement plan, build these fees into your costs. The problem is that price increases can be unpredictable, and if you switch managers your fees could jump. Many property managers also charge a mark-up on repairs, up to 50% of the repair’s total cost.

Which is another con of real estate investing for retirement – repairs. Homes and buildings must be maintained. Furnaces will need servicing or replacing, roofs could take storm damage and need to be replaced, or tenants kick holes in the wall or break windows.  Most experts advise setting aside 1-2% of your monthly rents for repairs.

Unlike retirement investment accounts, whose fees increase at predictable intervals and rarely for huge amounts, one bad year in a real estate portfolio could wipe out all your profits. And leave you with nothing to cover living expenses. If you do decide to fully or partially invest in real estate for retirement, evaluate the building’s condition and build major repairs into your long-term plans.

Vacancy rates can also become an issue. No property will remain rented 365 days a year. Plan on a rental vacancy rate of at least 10%, and keep an eye on trends in the area where you invest. It would be a bad idea to budget to use all of your rental income for your retirement living expenses. Save a little each month for both repairs and to cover the mortgage if the property becomes vacant.  

Property taxes are another negative to investing in real estate. The flip side of price appreciation is property tax increases which could cut into your profit margins. Special levies and city assessments could also cause your property taxes to increase, and you can’t always predict them. Some cities also charge different tax rates for non-owner-occupied properties.

When deciding whether or not to invest in real estate for retirement, carefully consider the pros and cons and crunch the numbers. Enlist a tax professional to help you structure your portfolio to keep the most money in your pocket.

Other Considerations when Thinking About Real Estate Investing for Retirement

Real estate investing isn’t easy, and investors considering this for retirement should think about how much time they have to put into their investment plan. Even if you hire experts to help you narrow down the best locations and properties for your investment, you should take the time to educate yourself about the local real estate market.

Most investors will want to visit the properties they’re thinking of acquiring, which could require travel. And there are other costs to acquire the properties in your portfolio. To even start real estate investing on your own you’ll have to pay home inspectors to examine your properties, real estate agent commission fees, mortgage fees, and points and closing costs. One of the downsides to real estate investing for retirement is the time and money it takes to ramp up a portfolio that’s broad enough to support your retirement goals.

The amount of money you have to invest could limit your real estate investing dreams. A 20% down payment on a rental property could be a good portion of your cash on hand. Don’t forget that commercial lenders charge higher interest rates and sometimes require larger down payments, too.

This is why it’s a good idea to start early before you need to live off the income generated by your investments.  You can roll the income you make in the first few years into acquiring other properties or paying down the mortgages on your existing rentals.

This is one of the reasons that many experts advise starting early and building your portfolio slowly. Don’t wait to start buying properties until one or two years pre-retirement.  Give yourself time to build a portfolio and learn the ropes of being a real estate investor.

Before you make any large investments for retirement sit down and talk to a financial professional and your accountant about your financial health and the tax implications.

Tax Implications of Real Estate Investing for Retirement

When calculating your profits and returns, don’t forget to deduct money for taxes. If you purchase property in an LLC or as an individual, the income will be taxable. It counts as ordinary income, and will for the entire time you own the property. Your age and retirement status has no impact on this, which is a downside to this form of investing for retirement.

Many retirement fund withdrawals are either fully or partially taxable, but in some cases only the gains are taxed.  Money withdrawn from a ROTH IRA is non-taxable as long as you meet withdrawal requirements related to age and the length of time you’ve had the account. High-net worth individuals should carefully balance their retirement portfolios to best manage their tax burden.

To avoid paying taxes on your rental income, talk to your tax advisor about investing through your IRA. Deducting depreciation and the above-mentioned costs associated with rental properties can also help reduce your tax burden.  

In conclusion, while real estate investment for retirement can bring in a steady income stream, it’s not without its drawbacks. Always talk to professionals before making a large change to your retirement investment strategy to make sure that you’re set up for success.

With the acceptance of the Tax Cuts and Job Act reform, we are now seeing the results of one of the most expansive tax law changes in nearly thirty years.  With this came large changes to the forms and reporting structures themselves.  No longer are Forms 1040-A or 1040-EZ available for use – everyone must file utilizing Form 1040.  While the Form 1040 itself is greatly reduced, there is additional paperwork that may need to be completed in order to properly calculate your tax breaks and deduction.  In June of 2018, the IRS released the first drafts of the form for review by its partners in the industry, and after revisions,  Form 1040 was approved and released for public use.  Much like prior years, the Form 1040 will utilize a summary of schedules format.  Taxpayers with relatively straightforward tax situations will be able to file a Form 1040 with no numbered schedules.  However, for those needing to file the form with additional supplemental information, the schedules are far more extensive, including  income and adjustments, tax calculations, credits and designations.

With nearly ninety percent of the taxpayers using tax software, most of the changes will be nearly seamless.  In fact, many may not even realize that there is a change if their software utilizes questions to complete the forms in the background.  For most filers, even those with a bit more complexity, the first two pages still contain the most commonly used lines,  so the difference may be negligible.  For those using the additional forms, here are the more common ones and what they cover.

Form 1040, Page 1 will include only the name and identification number of each person on the return, the return filers address, the checkbox for healthcare coverage, the checkbox for the Presidential Election designation, and the signature line.

Form 1040, Page 2 will continue to include most of the lines that used to be contained on Page 1 of prior year returns.  These are:  wages, interest, dividends, retirement payments, and social security; as well as a summary of the other income items.  The other  items that used to be on Page 2, for the most part, remain.  These are:  standard or itemized deductions, refundable credits and withholding.  It has added in income adjustments from Schedule 1, non-refundable credits from Schedule 3, and payments/credits from Schedule 5.

Schedule 1 will cover additional income items not listed above.  These are: taxable refunds/credits, state offsets for income taxes, alimony received, Schedule C business income or loss, Schedule D capital gains income or loss, Schedule F farm income or loss, unemployment and other non-specifically named income.  It also reports adjustments to income such as: educator expenses, business expenses reportable on Form 2106, health savings accounts, moving expenses, self-employment tax deduction, self-employed retirement plans, early withdrawal penalties, alimony paid, IRA deductions, and student loan interest deduction.  This category includes prizes and award money and gambling winnings as well.

Schedule 2 will cover additional forms of taxation such as the alternative minimum tax and excess advance premium tax credit repayment.

Schedule 3 will cover nonrefundable credits such as Form 1116, child and dependent care expenses, education credits, retirement savings contributions credit, residential energy credits, as well as other non-specifically listed credits utilizing Form 3800 (General Business Credit) and/or Form 8801 (Credit for Prior Year Minimum Tax).

Schedule 4 will cover self-employment tax, unreported Social Security and Medicare, additional taxes on retirement plans, household employees, first-time homebuyer’s credit repayment, health care individual responsibility tax, and other non-specifically named taxes utilizing Form 8959 (Additional Medicare Tax) and/or Form 8960 (Net Investment Income Tax) and/or Form 965-A (Individual Report of Net 965 Tax Liability (Deferred Foreign Income).

Schedule 5 will cover other payments and refundable credits not appearing on Page 2.  These are:  estimated payments and amounts carried forward from 2017, premium tax credit, amount paid with extension, excess Social Security and tier 1 RRTA tax withheld, credit for federal fuels tax, and non-specifically named credits utilizing Form 2439 (Shareholder Undistributed Long-Term Capital Gains) and/or Form 8885 (Health Coverage Tax Credit).  This also includes calculations for the Earned Income Credit, the American Opportunity Credit, and additional child tax credits.

Schedule 6 will cover foreign address and third-party designees.

The Qualified Business Income Deduction is also new this year and allows you to deduct up to twenty percent of your qualified business income from your qualified trade of business, plus twenty percent of your qualified real estate investment trust dividends and qualified publicly traded partnership income.  This is an additional deduction for self-employed taxpayers, over and above the standard deduction or itemized deduction.

With the increase in the standard deduction, there can be some  question of whether or not you need to file at all.  Below are the tax thresholds for 2018, although there still may be other reasons you are required to or wish to file:

• Single, under 65 – $12,000
• Single, 65 or older – $13,600
• Married filing jointly, both spouses under 65 – $24,000
• Married filing jointly, one spouse 65 or older – $25,300
• Married filing jointly, both spouses 65 or older – $26,600
• Married filing separately, any age – $12,000
• Head of household, under 65 – $18,000
• Head of household, 65 or older – $19,600
• Qualifying widow(er) with dependent child, under 65 – $24,000
• Qualifying widow(er) with dependent child, 65 or older – $25,300

You may still need to file a return if you:

• You had at least $400 in self-employment income.
• You owe household employment taxes.
• Social Security and Medicare taxes are owed on unreported tip income.
• You received a distribution from a medical savings account (MSA) or a health savings account (HSA).
• You received an advance payment on the Premium Tax Credit.
• Expect to qualify for the Earned Income Tax Credit.
• You’re claiming education credits and must file to be refunded under the American Opportunity Credit.
• You want to claim a refundable Health Coverage Tax Credit.
• You adopt a child and want to claim the Adoption Tax Credit.
• You had wages of $108.28 or more from a church or qualified church-controlled organization that is exempt from employer Social Security and Medicare tax.
• You had withholding.

All IRS forms and instructions are available online at IRS.gov.  Ordering forms may take up to ten business days to arrive.

One of the hardest things to do as a parent is to leave your child in someone else’s care so that you can go back to work.  Sometimes, preparing for the cost of that care can be nearly as difficult.  Some care centers can cost more than in-state tuition at a university.

More than sixty-five percent of American children have two working parents and many children will be in a child care program for much of their youth.  More than twenty percent of the family’s income can be  spent on child care over the course of the year and this cost can greatly influence career decisions.  Forty-two percent of American families rely on a relative or relatives to care for their children.  This can have a  significant upside -- allowing for one-on-one care with a familiar caretaker, often in a familiar environment and relatives can often provide a more flexible schedule.  One down-side is that utilizing a relative for childcare can put a strain on inter-family relationships.  In many cases the relative(s) taking care of the child are grandparents and the increasing mental and physical demands of a growing child came become too much.

Hiring a nanny or an  au pair can be a good option.  It offers many of the same advantages as relative care, with mostly flexible hours, in-home care and one-on-one attention, however, it is important to note that hiring a nanny or an au pair is not necessarily as straight-forward as it seems.  These types of caregivers are often the most expensive, since  parents will become the employer.  This  means conducting interviews/background checks/reference checks, preparing a contract, paying household employer taxes, potentially providing benefits, and arranging for back-up care if the nanny or au pair is ill.   It is costly, but  often you get what you pay for , as over fifty percent of nannies or au pairs have a degree in early childhood development or other child-related fields.  This may provide your child with a more educational or well-rounded experience.  In some cases,  if you work it into the contract, many will provide light housework in addition to childcare.

If you do not have a relative near-by or willing, and a nanny or an au pair is out of your price range, many parents opt for using an organized childcare facility.  These centers provide licensed and sometimes accredited places where children have the opportunity to experience things outside of the home and socialize with other children in their age groups.  Many centers include education, field trips and other programs that may be of interest to you and your child.  These centers can be quite costly as well, and in-home daycares are often more affordable.  In home daycare is usually limited in age and number of children  to be cared for and are  subject to different regulations.  They may not hold the same level of licensing or accreditation as larger centers or private care.    The state generally regulates the ratio of children to adult caregivers based upon age of the child.

There are several tax benefits to paying for childcare, since working parents are eligible for a non-refundable tax credit of between twenty and thirty-five percent of their child-care expenses up to $3,000 per year for up to two children under the age of thirteen.  This credit is limited by the amount of income made by the parents and parents making less than $15,000 a year qualify for the highest bracket of thirty-five percent, with the percentage dropping every additional $2,000 until it reaches twenty percent at $43,000 a year.  The Dependent Care Flexible Spending Account is an employer sponsored account that allows the parent to pay for up to $5,000 per household per year of child-care expenses with pre-tax dollars.  This means that a portion of the parent’s wage is taken out prior to being subject to federal, state, Social Security and Medicare taxes.  Keep in mind that you cannot claim both benefits for the same child care expenses.

When looking at childcare options, it is important to first determine your budget.  How much can you spend on childcare?  How will that change with one or both parents able to work?  Be sure to look into what savings options your employer(s) may have and if your employer has an FSA plan, calculate out how much you can set aside.  If your employer doesn’t have a plan, see what child care credits your may be able to take advantage of.  Do the research by interviewing the various childcare options in your area and seeing what may then fit into that budget.  Give yourself plenty of time, as this is a big decision and one that shouldn’t be rushed.    If you do choose to hire a nanny or au pair, make sure you understand the regulations that you must follow when adding a household employee.   Determine if full time or part time care is what you need, of if you can work a flexible schedule that allows for a few longer days but reduces the need for a full week’s worth of care.  See if you have friends with children of similar ages that may be interested in sharing a caregiver.  Look into seeing if you can work remotely a few hours or days a week.  Or perhaps find a side hustle that allows for extra cash without overtaxing your resources.

Childcare is a situation full of emotional and financial pros and cons.  It is important to enter into the decision making process fully armed and ready.  You should invest in a care system that works best for you and your family, while still providing the hours that are needed at a cost that works.

We often think that having a home in multiple states is a great idea, and sometimes we contemplate working while traveling between these homes.  In some cases, our jobs take us to multiple locations.  What happens when we work in multiple states throughout the year?

It is important to determine if you are considered domiciled in a particular state.  If so, you will be subject to that state’s income tax rules and regulations.  We tend to think of domicile as where we spend the most amount of our time, however, each state has different rules regarding the terms and conditions of what is considered a domicile.  Your domicile typically is where you have a “true, fixed, and permanent home”.  Your domicile will not change provided you have a home that you consider the place “to which you intend to return whenever absent”.   Your domicile can be different from your residence.  Your residence is based upon how much time you spend in a state.  These definitions of time that qualify you to be a resident, and therefore subject to taxation, differ from state to state.  Check the regulations for your state,  but keep in mind that most states include days spent in the state as a determining factor.  Some states also require an abode or overnight as a determining factor.  Even if you rent the home out while you are not there, it could still be considered an abode when it comes to the state determinations.  It is recommended that you thoroughly document your use of a second home and/or business.  Most states will default to resident status, and it is up to you to provide the facts and evidence that you were not qualified for state taxation.

Many states also tax you on your worldwide income if you qualify for a domicile or resident status.  Additionally, if you work in another state, you will most likely need to pay taxes on the income derived from that state.  Some states separate the income and tax only their state’s income, while others calculate tax on all income as if you were a resident and then allocate the tax based on in-state sources/all sources.  You may also have to file in another state if you are an S-Corporation shareholder and the business operates in another state, you are a partner in an out-of-state partnership, you own rental property in another state, or you are the beneficiary of a trust in another state.  These are factors that create a nonresident return filing in another state.  These rules apply even if the partnership is held in an investment account.

Regardless of whether you are a part-year resident or a nonresident in the state where you are working or residing, you will probably need to complete an apportionment statement for the income.  This is generally found in each state’s tax return forms.  Part-year residents usually not only pay taxes on income earned from work performed in the state, but also pay tax on all other income received while a resident of the state.  A nonresident will generally only pay taxes on income they earned while performing work in the state, and on income received from other sources within the state.  After you determine your apportionment allocations, you will need to calculate what percentage of your total income is applicable to the state.  This is the apportionment percentage and is used in the additional calculations of the taxation.  Apportionment can be done in one of two ways, depending on the requirements of the state.  Some states require you to calculate your taxes as if you were a resident for the entire year.  Once you have calculated a full year’s worth of income for the state, you then apply the apportionment percentage to this tax to determine what you owe in that state.  The other method is to prorate your itemized deductions and other allowable deductions and credits using the apportionment percentage, so that the taxes you pay to the state are based solely on this prorated amount.

If you are a nonresident, you will still need to use the apportionment allocation form to determine how much tax you will owe in each state.  You will also pay tax on all of your income for the entire year to your resident state.  To many people this sounds like double taxation, and it is, although most states allow you a credit on your resident return for the taxes paid to another nonresident state. Under the law of each state, tax credits are only available with respect to the income taxes that are properly due to another state.  When two states can claim you as a domiciliary, neither state believes that taxes are properly due to the other.  You will need to prove that you are abandoning one domicile for another to avoid taxation in both states.  Be cautious in nonresident filings, as the nonresident states may carry a higher taxation rate than your resident state, or your resident state may cap the amount of credit you can apply.  If you have enough deductions in your resident state that don’t qualify for your nonresident or part-year state, you may end up not being able to reduce the income being taxed.  If this is the case, you won't have enough resident state taxes to use the full credit from the nonresident state, and you can't carry over the excess nonresident taxes to use as a credit in a later year.  This may mean that you will end up paying more taxes in the long run.

Calculating multi-state qualifications and taxation is complex.  It is best to seek the advice of a tax professional prior to engaging in activities in another state.  Be sure you fully understand the rules and regulations of each state you intend to reside, do business with, or invest in, as it  is critical to avoiding unnecessary taxation.

The Tax Cuts and Jobs Act of 2017 has led to changes in the way companies choose to be taxed.  Prior to the tax reform, many businesses were required to use the accrual method of accounting.  But with the change in tax law, businesses with $25 million or less in annual revenue over the prior three years can use the cash method.  More businesses are choosing the cash method of accounting instead of the previous accrual method, but what is the difference between cash and accrual methods of accounting?

Every business must make a decision on how and when to record income and expenses.  Making the choice between the cash and accrual methods is about the timing of when revenue and expenses are recognized and reported.  On their most basic levels, cash accounting is a recording of the transaction when the money actually changes hands, while in accrual accounting the transaction is recorded when it is earned or established.  Cash is immediate and accrual is anticipated.

With the cash method of accounting, revenue is counted when it is received from the customer or client, therefore the  cash method business will not have accounts receivable.  The cash method business also has no accounts payable, as when the expense is paid to the supplier or employee, the transaction is recorded.  There are advantages and disadvantages to the cash method of accounting.  One advantage comes in the cash method’s simplicity.  Since revenue and expenses are only recorded when they happen, the tracking of the company’s cash flow is straightforward.  It is easy to determine when a transaction has occurred because the money is, in clear terms, either in or out of the bank.  This means that, in general, the financial records on any given day are an accurate reflection of the company’s resources.  Since the income is not recorded until it is received, it is also not taxed until it is received.  The cash method allows for  easier income deferral, and easier expense increase, which may present a misleading picture of the company’s financial state.  If the company delays sending  invoices, the customer will not make the payment.  If this crosses years, it will shift the taxable income into a different year than the year in which the service was provided.  If a company chooses to pay its vendors immediately or even pre-pay them, then the expenses will be increased.  For example, if a company prepays its January rent in December, the expenses will be taken against the income for the year that is ending, rather than the year that is just beginning.  The company can also choose to do the opposite and hold on to large amounts of payables, potentially more than the cash on hand, and thereby overstates the health of the company.  Cash method accounting, while easier, can create varied results based upon when to receive income and when to pay expenses.

In contrast to the cash method, the accrual method utilizes  different timing in regards to income and expenses.  In this case, revenue is recorded when it is earned with the expectation that the customer will pay the invoice in the future.  The expenses for goods and services provided to the company are recorded when they are incurred, even if no money has left the bank.  Because of this, the accrual method often shows a more accurate picture of how the business is doing over a longer period.  One disadvantage of the accrual method is that it is harder to account for the cash flow of the business.  It also means greater complexity in reporting by creating the need for dealing with unearned or deferred revenue and prepaid expenses.  Unearned revenue is when money is received by the company for work not yet completed – essentially a prepayment.  This  income cannot be recognized on the income statement, and instead is reported on the balance sheet as a liability.  As the service is provided, the portion of the provided or earned service is moved from the liability to the income statement.   Generally, these are expenses that will be used within one year, as opposed to deferred expenses that are utilized over the course of more than one year.  Prepaid expenses are recorded as assets on the balance sheet until a portion of them is incurred and then it is moved to the income statement.  Accrual method accounting is not without the ability to flux reporting as well.  Like the cash method, you can increase your income by sending out invoices, or decrease them but holding back invoices.

Accrual method also allows for the write off of bad debt.  Bad debt is when you have a customer who you do not believe will pay you.  You have already recorded the income when the customer was invoiced, thereby making it taxable.  Bad debt allows you to remove this income before taxation.  It should also be noted that because income is recognized when earned, that income may also be taxed before the funds are received from the customer.  Because accrual does not show the current cash accounts of the business, it is vitally important to track the businesses funds alongside the income statement.

In general, your accounting method is chosen when you begin your business and file your first return.  If your business qualifies to use either method, you may choose to switch using Form 3115 for approval from the IRS.  You will need to complete a Form 3115 if you are changing from cash to accrual (or vice versa), as well as from FIFO to LIFO (or other method) for your inventory, or from one depreciation method to another.  Before changing your method, research should be done on the resulting adjustments to taxable income.

“You should sell those.”  It’s a phrase many people have heard when showing someone their crafts.  When does a hobby become a business?  Is it when you first start selling your items?  Is it when you first turn a profit?  When can you start deducting expenses against the income?

While the IRS makes a distinction between a legitimate business and a hobby, it is often hard to determine when your business has crossed over that line.  And Ultimately, it is the IRS, not the taxpayer, that determines if the business is legitimate and not a hobby under audit.  Many legitimate businesses start out with a loss in their first few years, so profitability alone is not a factor in determining if you have a business.  The IRS defines a business as having a primary purpose of income or profit and is actively engaged with continuity and regularity.  In general, this means the IRS looks at nine factors to determine if the business is legitimate: 1.  Did you keep accurate records?  2.  Was the time and effort put into the business indicative of making a profit given the right circumstances?  3.  Is the taxpayer is dependent on the income?  4.  Are the losses incurred beyond the taxpayers control?   5.  Does the taxpayer have a plan or method for conducting business and making changes to garner a profit?  6.  Does the taxpayer have the skill set needed?  7.  If a prior similar business was owned, did it make a profit?  8.  Does the business have a profit in some years, if not all?  9.  Is there the means to make a profit in the future?   The IRS often employees the idea that a business will make a profit in at least three of the last five years, (or at least two of the last seven if the product is related to livestock).  While this is not a rule, it is a good guideline to follow.

If your business falls outside of these generalizations, the IRS may consider it a hobby.  A designation as a hobby does not exclude you from having to report the income on your return.  This is usually done on the Other Income line of Form 1040.  The hobby rules limit the method in which you can take deductions against the income.  This is when the difference between a hobby and a business becomes important.  A business can offset income with all ordinary and necessary expenses by deducting them against the income and can carry those losses back or forward to offset income in other tax years.  Hobby expenses are limited to the amount of income you make, so you can never deduct additional losses.  Furthermore, you must itemize on Schedule A to claim the losses.  If your total hobby expenses, along with any other miscellaneous expense that fall into this category, are not more than two percent of your adjusted gross income, or you do not itemize deductions at all, you cannot claim the hobby expenses.  There are 3 categories of deductions that your hobby expenses may fall into, and these deductions must be taken in the following order:  1.  deductions you can take for personal as well as business activities are allowed in full (including those for home mortgage interest, taxes, and casualty losses).  2.  deductions that don’t result in an adjustment to the basis of property are allowed next, but only to the extent that your gross income from the activity exceeds your deductions under the first category.  3.  business deductions that decrease the basis of property are allowed last, but only to the extent that your gross income from the activity exceeds your deductions from the first 2 categories.  Since the Tax Cuts and Jobs Act of 2017 was passed, the standard deduction will be taken by most taxpayers, and the hobby expenses deduction will no longer make sense for most.

Once a hobby qualifies to become a business, the taxpayer will likely declare it on their Schedule C.  The net income from the business is then included on the individual's personal tax return and is subject to both income taxes and self-employment taxes.  If your business is an LLC or partnership or S corporation, you would prepare a tax return for that business and take the resulting income over to your personal tax return.  This also opens up the ability to deduct the business expenses directly against the income.  As many Schedule Cs are subject to higher scrutiny by the IRS, especially in the early years, it is critical to maintain detailed records outlining your efforts in advertising, meetings, trying to obtain income or sell services, mileage logs and work logs.  As there are no concrete rules for determining when your hobby becomes a business, only that a business must actively be trying to make a profit, you need to effectively show every effort is being made.

In a nutshell, the difference between a business and a hobby comes down to how expenses/losses are treated, as income is always reportable.  Business expenses and losses are fully deductible, while the expenses related to a hobby are only deductible up to the amount of any income you earned from your hobby.  Much of the confusion for taxpayers occurs when they classify their hobby as a small business because it generates some income, and then take full deductions against the income for expenses.  The IRS’s enforcement of hobby loss rules means if you truly are operating a business, you need to treat it like a business, and be prepared to prove your claim to an IRS representative.  The first few years are always the hardest, while the business is finding its feet and are also the most reviewed by the IRS.  So, while a loss in the first few years is not going to delegitimize your business, you must prove your methods and the validity of your business if under audit.  Be sure to record accurate and complete accounting records.  Be sure to comply with all federal and state business laws by ensuring you have proper permits, insurance, licenses and tax reporting numbers.  Have a marketing plan and act on it – get business cards, print brochures, run ads in local papers.  Growing enough revenue to ensure a profit over and above your expenses is a gradual process.  Make sure that you do it right from the start and can prove to the IRS it is a real business and not a hobby.

In recent years, raising money online through third-party backers, or crowdfunding, has grown in popularity.  Originally utilized mostly by musicians, filmmakers and for other creative endeavors, it has now become a more widespread method of raising money for a trip, medical expense, or startup, and is often a quicker and easier alternative than conventional fundraising.  Often the creator of a campaign puts little thought to the tax ramifications before launching and collecting the funds.  With this increase in utilization, the business of its taxation has become an increasing question.  While Congress and the IRS have not addressed crowdfunding income specifically, applying standard tax principles and common sense may help when talking through the issues surrounding taxable crowdfunding income and deciding how to report and pay taxes on it.

First,  it is important to note there are three types of crowdfunding: donation-based, reward-based, and equity-based.  Donation-based crowdfunding is when people donate to a cause, project, or event – often known as Life Event Fundraising.  GoFundMe and Indiegogo are the most well-known examples of donation-based crowdfunding with pages typically set up by a friend or family member to help someone pay for medical expenses, tuition, or natural disaster recovery.  These campaigns typically have no business activities and the donors receive nothing in exchange other than the knowledge that they aided another person in their struggles.  As the donor did not receive anything in exchange, it is generally considered a non-taxable gift to the receiver and there is generally nothing to report on their return.  Most life event fundraisers are not set up through a 501(s)(3) or other charitable organization, and therefore, the donor will not be able to report the gift on their return.  Gift tax limits would be the only item necessary to take into consideration, although in most cases donors will not donate over the annual limit.

Reward-based crowdfunding involves an exchange of goods and services for a monetary donation.  Sites like Kickstarter are often utilized for this type of funding.  These funds are likely taxable on the federal level, and may even be subject to state level excise, sales and/or business and occupation taxes.  Reward-based funding often involves setting a goal and offering a small gift to the donors in exchange for their donation.  Due to the fact that something was offered in return for a payment pledge, it is considered a sale.  The funds from these transactions may appear on a Form 1099-K for reporting unadjusted gross revenues, just like a traditional credit card processor, if the transactions and their values are high enough to meet the threshold.  Generally, revenues like these are considered income as long as they are not: loans for repayment, capital contributed in exchange for equity interest (more on that below), or gifts “made out of detached generosity.”  Additionally, as these funds are usually considered income, expenses could be deducted, based upon whether the business is a start-up, accounting method used, and other receipts.

It is important to note, if the campaign offers a reward in exchange for the pledge, if the reward’s value cannot be determined, or if a reward is determined to have no value or a value less than the pledge amount, additional evaluation may be required to determine whether all or part of the contribution can be classified as a nontaxable gift or some other type of contribution.  Gift treatment would be disallowed where the reward has a value approximately equal to or greater than the contribution.  Therefore, amounts received in a reward-based crowdfunding campaign that promises a reward that has some value, is unlikely to be considered a gift.  Contributions from backers who choose to forgo the reward might be treated as nontaxable gifts, but the exact circumstances of the contributions must be considered.

If the company running the campaign is a start-up, the owners may have start-up costs and/or organizational costs.  These must be capitalized unless the taxpayer chooses to elect to use Section 195, Section 248, or Section 709 for start-up or organizational costs, accordingly, and can then deduct up to $5,000 of the costs (reduced by the amount by which they exceed $50,000).  The deduction is taken in the year in which the trade or business becomes active for start-up costs, or the business begins business for organizational costs.  The remaining amount is amortized over a fifteen-year period beginning in the month in which the business becomes active or begins.  A taxpayer is deemed to make the election to deduct and amortize these expenses unless they affirmatively elects to capitalize them on the return in which the trade or business activity begins, or the entity begins business.  For start-up or organizational costs to be deducted, the business must be active.  Largely this depends on facts and circumstances and conducting a crowdfunding campaign alone may not be enough to be considered actively engaging in business.  Therefore, the related expenses may not be considered deductible until later.

Many of the crowdfunding campaigns do not guarantee the completion of the project or the delivery of the reward.  This means once creators receive the funds, they have complete control over them, even if they do not complete the project and deliver the reward.  Regardless of the date of the completion of the project, if any, this income is taxable in the year of receipt regardless of the creator's accounting method.  This can create a timing problem if the income is taxable in one year but the related expenses, which would usually be incurred after completion of a campaign, are not deductible until the following year.

In equity-based crowdfunding, donors receive equity for their contribution.  This became a popular venture in 2009.  It allows people to invest in the early-stages of a private company in exchange for shares or percentages of ownership in that company.  Investment crowdfunding needs to be entered into carefully because soliciting investments from the public can be illegal with the SEC.  However, when done correctly,  it can greatly enhance a business with strong growth potential.

While it is still unclear on many levels how crowdfunding is being taxed, the treatment of funds generated through crowdfunding depends on the method of fundraising and the value of any reward offered.   It is therefore important to properly track your campaign and consult a professional before-hand.   Don’t make the mistake of being caught at tax time with no funds to pay the taxes on your campaign.

With the close of 2018, we begin to look ahead to 2019 and ensuring that we set ourselves up for a good tax outcome at year end.  There are many things to consider as you move through the tax year and some require pre-planning to ensure maximum benefit.

The first thing to do is ensure that you are withholding enough from your paycheck or distributions or paying in enough through estimated tax payments.  While you don’t need to pay your taxes due until April of the following year, it is important to get close to avoid penalties to the Internal Revenue Service.  Be sure that you meet at least the safe harbor tests to avoid the penalties.  These are:  you end up owing less than $1,000 after your prepayments; you’ve paid in at least 90% of what you owe for the current tax year; and you’ve paid in at least 100% of what your owed for the prior tax year or 110% if your income is $150,000 (for 2018).  With a paycheck, the withholding is taken out each pay period and deposited with the IRS, thus insuring that the taxes due on the income are deposited throughout the year.  The same request can be made of distribution checks from retirement funds.  For the self-employed, however, the vehicle becomes estimated tax payments, which are due once a quarter mid-April, June, September and January of the next year.  These payments are generally calculated using your prior year’s figures.  You should be sure to track your net income throughout the year to ensure that you are on target and do no need to make adjustments up or down in your payments.  While the IRS won’t penalize you for not making enough prepayments to cover the increased tax liability, (provided you paid in at least the prior year’s liability and are not over the income limit), being hit with a large tax bill and additional current year estimated payment in mid-April can be tough.

If you are still working, a great tax advantage is contributing to a 401(k) or similar plan through your employer, if available.  The limits for 2019, will be $19,000, with a $6,000 catch-up for those employees that are fifty or older, for a total of $25,000.  There are tighter restrictions to those employees that qualify as highly compensated, in this case employees with a starting salary of $120,000 or more.  You will need to contribute to your plan no later than December 31st of the year in which you want it counted.

For those that are over seventy and a half (70 ½) years of age, you are required to start taking required minimum distributions from your Individual Retirement Arrangement (IRA), as well as most company-sponsored retirement plans.  The penalty for failure to take your required minimum distribution is a fifty percent penalty.  The IRS does this by taking the amount of RMD you should have taken based on life expectancy rates and the value of your retirement account balance as of the end of the previous year and multiplies it by fifty percent.  It is important to note that as you get older, your life expectancy rate will decline and your RMD amount will increase.  Work with your tax preparer and broker to determine your yearly RMD.  RMDs are required for those not 70 ½ if they are the spousal beneficiary of an inherited IRA, 401(k) or other retirement account and qualify for stretch distributions.  Roth IRAs and 401Ks are not subject to RMD provisions.  This makes them a good safety net for keeping your money long term for later use or heirs, as well as earning tax-free income during your life time.  If you do not have a Roth, you may want to look into converting your traditional retirement plan to a Roth before the RMD age.  You will pay taxes on the conversion, but you may save more taxes by keeping your RMD down, as RMDs are subject to taxation and may force more of your Social Security to be taxable (and Medicare Part B premiums could be affected).

There are several things you can do that will be helping your children, and some of them may have tax benefits to you.  One thing you can do is gift any person up to $15,000 in a single year without having to count it against your lifetime gift exemption.  As this is a person to person transaction, both you and your spouse can gift to a child, thereby giving them $30,000.  Additionally, if they are married, you can also each gift to their spouse.  Another way to assist your children, and potentially take a tax benefit, is to contribute to a 529 plan.  These are savings plans that grow tax free for use for qualifying educational purposes.  While these are not deductible for Federal tax purposes, may states offer a tax deduction for the contribution to the state’s plan(s).

Another way to potentially save on taxes is to sell stock at a loss to offset any gain incurred during the course of the year.  While no one like to take a loss, it can be worth it if you know you will incur a large tax hit.  Additionally, you can take an additional $3,000 a year loss against ordinary income over and above the capital gain offset.  Any additional amount gets carried forward to be used in the following year(s).  Be sure to not rebuy until 30 days after the sale, as you cannot deduct the loss otherwise. 

Try to maximize your Schedule A itemized deductions by grouping your donations to charity into a single year instead of spreading them out over more than one year.  You can also group as much property tax payments as possible into a single year for taxes that you have already been billed for in the current year.  With the reduction in ability to take more than $10,000 in accordance with the Tax Cuts and Jobs Act, this deduction will not go as far as it used to.  Be sure to use your flexible spending account to assist with medical expenses, as most taxpayers will no longer qualify for the benefit on Schedule A.

Vehicle purchases are one of the largest expenses for most families.  With an increase in people choosing to lease instead of buy, what are the differences?  As with most decisions in life, taxes should only be one of the considerations.   A few of the non-tax considerations on buying or leasing a business vehicle: number of miles you drive each year, how long you keep a car, how much do you want to spend on your monthly payments?

You may be able to deduct your lease payment, prorated according to how much you use the car for business. For example, if your lease payment is $300 a month and you drive your car for business 50 percent of the time, you can deduct $150 a month as a business expense.  There’s one catch though.  If the car exceeds a certain value, you must subtract an “income inclusion” amount from your deduction. This is an additional amount of income you may have to report if you lease a vehicle or other property for business purposes.  You must report the inclusion amount if the fair market value of the leased asset exceeds a certain threshold ($50,000 for a vehicle first leased in 2018).  The inclusion amount differs depending on how long you’ve leased your car.  Leasing offers tax advantages for self-employed people who drive for work, especially for more expensive cars.

As the price goes up on the car, leasing usually becomes more preferable.  But don’t forget if you purchased the vehicle, you can also deduct the interest on the vehicle’s loan based on the percentage of business use.  If you purchased a car this year to transport passengers for self-employment jobs like Uber and Lyft and you bought a sports utility vehicle, you may be able to deduct up to $25,000 of the cost of the vehicle if you use it more than 50% for your business. If you purchased a car for your business, you may also be able to deduct up to the depreciation deduction allowed if your business use is more than 50%.

With both purchased and leased cars, you can deduct the related expenses by using the standard mileage rate or actual expenses.  Note: If you own the vehicle, you can choose the standard mileage rate in the first year and switch to the actual expense method in a later year if it becomes more favorable.  If you lease a vehicle, you may also choose the standard mileage rate in the first year, but once you use the standard mileage rate you must use it for the life of the lease.  In addition to mileage, you can also deduct business-related parking fees and tolls.  Under the actual expense rules, for both leased and purchased vehicles, you can deduct the business percentage of your gasoline, oil, insurance, garage rent, parking & registration fees, lease or rental fees, repairs, tires, loan interest, etc.  Some expenses differ between purchased and leased vehicles using the actual expense rules, and because you don’t own a leased vehicle, you can’t depreciate it.

There is one more difference between buying and leasing a business vehicle, which is the disposition of the vehicle.  When you dispose of a business vehicle that you own, there may be a taxable gain or deductible loss.  The portion of any gain that is due to depreciation will be taxed as ordinary income. When you return your leased car to the dealer, there is no taxable gain or loss.

If you are not looking at the tax deductibility of buying or leasing, then the benefit will really depend on other factors.  Buying is usually the way to go if you have young kids or haul heavy machinery in your car.  When you return a leased car, a little wear and tear is okay.  However, the car needs to be close to its original condition or you’ll be charged for damages.  Moreover, you may need to show documentation that you got all the recommended oil changes, tire rotations, and tune-ups.  Usually, purchasing a pre-owned vehicle is the most financially savvy decision. That’s because you avoid steep first-year depreciation.  On average, a new car loses ten percent of its value when you drive it away from the dealer and ten percent more during the next year.  A new car loses an average of 60 percent of its total value during the first five years.  Moreover, car insurance and vehicle registration fees are also usually lower for slightly used cars.  However, maintenance and repair costs may be higher.  If you can buy a pre-owned car with cash, you’ll skip interest payments and come out even further ahead financially.

Most car owners keep new cars for six years.  If you plan to keep yours that long, buying is usually the better option, especially if you can pay off the loan during that time and build equity.  It’s usually easier to get an auto loan than a good lease deal, especially if you’re rebuilding your credit.  Leasing a car usually requires less expensive upfront costs and monthly payments compared to buying, but purchasing a vehicle is generally cheaper in the long run.  Most leasing companies charge 12 to 15 cents for every mile driven over a set limit (usually 10,000 to 15,000 miles per year), which can add up. You can negotiate for a higher mileage limit, but you’ll probably have to pay more for the lease.

Leasing may make more sense if you are financing the entire purchase of a car you keep for less than three years usually doesn’t make financial sense.  However, if a car is expected to have higher than average resale value, it may still be worth buying.  When you lease, you only pay for the difference between the sticker price and the car’s expected value at the end of the lease, plus interest and fees.  If you have excellent credit, you may not even need a down payment.  It’s almost always cheaper in the short term to lease a car rather than buy it.

There are excellent financial incentives for purchasing a new electric car, including a federal tax credit and rebates in some states.  However, eighty percent of electric car drivers lease.  Why?  First-year depreciation is even steeper for electric cars than for gas-powered cars.  On average, electric cars manufactured in 2016 lost fifty-two percent of their value during their first year.  Moreover, batteries degrade over time, and battery technology is quickly evolving.  The electric vehicles manufactured in two to three years will likely have much better range than today’s electric cars.