Tax Planning

“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.

In 1993, then President Bill Clinton sought to find a support system to aid the rapid growth in the workforce, which was increasingly made up of women with families.  The Family and Medical Leave Act (FMLA) was passed “to balance the demands of the workplace with the needs of families.”  This Act allowed both women and men to participate in work, but also protect them if a medical need arose.  Under this Federal Act, employers with fifty of more employees were required to provide up to twelve weeks to attend to serious health conditions of the employee, a parent, spouse or child.  It also provided for pregnancy and care of a newborn, adopted child or foster child.  In order to qualify, the employee needed to have worked in the business for at least twelve month and worked at least 1,250 hours over the past twelve months. (In 2008, different requirements and time periods were given to active duty families.  This leave was unpaid leave, and merely protected the employee’s right to benefits during the leave and return to their job or one of equal level, compensation and benefits.  Note that highly compensated employees have more limited rights when it comes to FMLA.

States are allowed to extend the benefits to FMLA if they so choose.  By 2016, four states had increased the benefits to include paid leave.  In 2019, Washington state will join California, New Jersey, Rhode Island, and New York.  Other states have dropped the threshold from fifty employees to less, and some have expanded coverage terms.  In 2008, the Act was amended to broaden the definition of family member for military families to include next of kin and adult children.  In 2010, the definition of “son and daughter” was clarified to ensure that the benefits covered those employees who assume the role of caring for a child regardless of their legal or biological relationship.  This change, along with February 2015 decision by the Department of Labor to redefine the definition of spouse, allowed for FMLA leave rights to cover same-sex and common-law marriages.  With these state level changes, some states also enacted payroll taxes to cover the increased payout costs and state programs and grants related to FMLA.  It is important for employers to ensure that they understand the requirements of their state, along with any taxation regulations linked to FMLA.

A new tax credit related to FMLA is available to eligible employers, even if they are exempt from providing FMLA.  Eligible employers are ones that have a written policy in place by the end of 2018 that requires the employer to provide at least two weeks of paid leave to qualified full time employees.  Part time employees can count towards eligibility if the leave is prorated for part time employees.  It is important to note that the IRS has stated that eligibility is calculated on expected normal work hours.  Overtime unless it is regularly scheduled, and discretionary bonuses are excluded from this calculation.  This credit is currently only available for the 2018 and 2019 tax years.  Tax practitioners may come across this credit during the 2018 filing season and should be aware of how to calculate the credit.

Under the credit, the definition of eligible employee is different than those of FMLA.  Again, under FMLA, the employee must have worked for the employer for a full year, not be highly compensated, and worked at least 1,250.  For Sec. 45S, the employee does not have to work the full year consecutively and the employer can use any method reasonable to determine whether the employee has been employed for one year or more.  Additionally, Section 45S does not require and employee to work the minimum number of hours per year to qualify.  Highly compensated employee is defined for the credit as being paid more than sixty percent of the applicable amount under Section 414(q)(1(B).  For 2018, the amount is $120,000, thereby making highly compensated employees anyone paid over $72,000.

Additionally, although FMLA allows for employees to elect, or employers to require, that employees substitute FMLA leave with any accrued vacation or sick leave, these leaves do not qualify for the tax credit unless that requirement is restricted to one or more of the following leave purposes:

• Birth and care of a newborn child of the employee;
• Placement of a child for adoption or foster with the employee;
• Care of the employee’s spouse, child or parent with a serious health condition;
• Employee’s inability to perform their duties due to serious health condition;
• Qualifying exigency arising from employee’s spouse, child or parent on covered active duty or call to active duty; or
• Employee who is the spouse, child, parent or next of kin to a covered servicemember to care for the service member

The FMLA credit equals an applicable percentage of the amount of wages paid to qualifying employees during their leave.  The wages paid to the employee must be equal to or exceed fifty percent of their regular and normal wages, up to one-hundred percent of regular and normal wages.  The credit’s applicable percentage is twelve and a half percent (12.5%) of the wages paid to the employee for leave during the calendar year and increases by 0.25 percentage points for each percentage point of wages paid for leave over fifty percent of normal wages.  This means that the maximum credit is twenty-five percent (25%) which is made up of 12.5% plus (50% multiplied by 0.25%) of wages paid for leave at a rate of 100% of normal wages.  The credit is limited to each employee’s hours of leave taken, multiplied by the employee’s normal hourly rate of pay when in service to the employer.  The method for converting a non-hourly rate employee to hourly for this calculation will be established under IRS regulation Sec. 45S(b)(2).  Until then, employers may use any reasonable method.  The current suggested method is to utilize the Fair Labor Standards Act of 1938 (FLSA) to determine regular rate of pay.  The employer must reduce the amount of the deduction claimed for wages and salaries paid by the amount of the leave credit.  This credit, when combined with all general business credits, cannot exceed the taxpayer’s net income tax over the greater of the tentative minimum tax or twenty-five percent of the taxpayer’s net regular tax liability that exceeds $25,000.  The excess, if eligible, can be carried back one year or forward twenty years.

You had a great idea and now you’ve put it in motion as a business.  And while income recognition is easy to determine, qualified business deductions can be a bit harder.  So… what are the most common tax deductions for small businesses?

Any materials you utilize for marketing your business and the cost of developing these can be deductible.  This can be advertisements in print or media, brochures, branded promo items, events or trade shows. Non-branded gift cannot be deducted.

Business insurance that is intended to protect your business as well as medical insurance that is paid by the business for its employees.  Auto related insurance falls under a different set of guidelines.  A portion of your vehicle expense can be taken related to the business use of the vehicle, unless standard mileage is taken instead.

Depreciation and Section 179 expenses on capitalized business assets such as computers, office furniture, tools and equipment, and the like.  Leasehold improvements and other real estate related capital expenses cannot be taken under Section 179.  Special depreciation rules have been approved by the IRS in certain years that speed up depreciation life in qualified assets.

Home office deduction relates to the specific portion of your home that is utilized solely for business.  This deduction is often misunderstood and abused.  You must designate a space that is used exclusively and regularly for the trade or business. In general, this must be an actual office and not a convenient space in your home.  More importantly, this space must only be used for business.  To figure the deduction, you must take the costs associated with your home that relate to the space (rent, utilities, insurance, mortgage interest, real estate taxes, etc.) and then calculate the percentage of use of the home for the business.

Office supplies that you use and replace such as pens, paper, toner, hot/cold bags for deliveries, etc.  Supplies that are used to create a product are considered Cost of Good Sold and are also deductible, as is the labor to create the product.

Travel related to business trips are deductible, such as airfare, lodging, rental cars and so on.  If the trip has an element of personal costs or entertainment, these portions are not deductible.

If you travel for business, you can deduct the mileage driven to do your job at the IRS standard rate for the year.  However, you cannot deduct the mileage for commuting to and from your job.  If you leave your house and go directly to the client site, without stopping at the office first, you must still deduct the mileage that would have been considered commuting from your total miles.  For example, if you went to a client site 14 miles away, but your normal commute to work would have been 4 miles, you can only deduct the 10 miles that are over and above your commuting miles.

Meals and entertainment have always been heavily scrutinized by the IRS.  With the new tax law changes, very few deductions will be allowed for company provided meals, and even less for employee related entertainment and benefits.  A good rule of thumb for currently meals that are deductible at 50%: client meal out and business discussion is the focus of the meal; travel meals; meals provided by the employer to the employee for the employer’s convenience; seminar/meeting meals; and office provided food/coffee. Meals that are 100% deductible are food provided to the public and certain office parties that are not extravagant in nature.  And entertainment of a client with no business-related interaction is not deductible.  Seeking the advice of a tax professional to determine which of your meals and entertainment qualify is advisable.

The costs of employees are also deductible including wages, employer portion of payroll taxes, employer provided benefits, dues and association costs, licensing, and retirement/pension plan employer costs.

Other less thought of deductions include: bank fees, education or training, library or industry related subscriptions, commissions and fees, contract labor, janitorial, depletion, interest on loans or investments that utilized the funds for the business, legal and professional fees, rent or lease of a vehicle or equipment, repairs and maintenance, utilities, and taxes and licenses.  Keep in mind that education costs must not be to qualify you for a new career.  These fall outside of the realm of a business deduction.  Also, starting in 2018, businesses with average annual gross receipts in the three prior years of more than $25 million are limited in the percentage of interest that’s deductible. Interest on loans by owners to buy their businesses are treated differently. Interest from an owner’s investment interest or passive activity interest is not a business deduction.  Estimated, Federal or State taxes paid on behalf of the owner as reported on the personal returns are not deductible.  Owner draws are not deductible to the business.

Business gifts are deductible, but only to a limited extent.  The IRS allows for a deduction of only the first $25 worth of gifts to each customer.  Meaning, that if you were to spend $100 on one customer, you would receive a deduction of $25.  But if you were to spend that same $100 on four customers, you would be able to deduct $25 for each customer, or the full $100 spent.

Certain items are never deductible by the business.  Some of these things are: fines and penalties for breaking the law, life insurance premiums if the business is the beneficiary (directly or indirectly), and political donations.  Unless it’s a required uniform you have to wear for work, or protective clothing, you cannot deduct business clothing.  Likewise, cellphone usage is limited by the amount of business use versus personal use.  This must be well documented.

Charitable contributions made by the company are not deductible by the business itself unless it is a C Corporation.  These will flow through to the owner’s personal return and be deducted on Schedule A if they itemize.

There are many different business deductions, each with their own unique qualifications.  It is important to review these with your tax professional.

As the holidays near, more and more shoppers are turning to online methods of procuring that special gift.  And it makes complete sense.  The world of e-commerce opens the buyer up to products that may be unavailable in the local area, and it’s often cost-efficient.  With this massive turn in consumer spending, tax systems are struggling to keep up.  By now most taxpayers have heard of the South Dakota v. Wayfair ruling that overturned the 1992 Quill case and now imposes sales taxes on retailers with no physical presence in the state, as long as they have a clear connection to state consumers and certain threshold of sales.  With this, smaller brick and mortar shops may start to see an increase in their sales again.  It will also help local state and municipalities by bringing in more revenue through the taxation.

It is not great news for businesses that rely on e-commerce sales, however.  Smaller businesses will feel the impact of Wayfair far more than larger companies like Amazon and Overstock.com.  These large-scale businesses have been anticipating and preparing for these changes for years.  In fact, many of them have already been collecting and submitting sales tax with the assumption that this is where the nation was headed.  It is the smaller companies that merely dabble in online or across-boarder sales, that need to bring themselves up to speed on the new regulations and how it will affect them.  Likewise, new start-ups that plan to rely on e-commerce need to understand where they will ow taxes, and how much tax they will pay in each state in each year.  Small retailers should brace themselves for state and local tax collectors, as well as auditors, to start scrutinizing their operations looking for any missed taxation opportunities.

Since the inception of the world wide web in 1991, online shopping has increased.  In fact, even though internet sales were a relatively new idea, in 1992 the Supreme Court ruled on their taxation in the case of Quill Corporation v North Dakota.  In the case of Quill, companies only had to collect sales tax for transactions that fell in a specific state where the company had a physical presence – meaning a brick and mortar retail store, employees, warehouse or office building.  On the surface this seems perfectly reasonable.  Afterall, these businesses are not contained within the state and are not benefiting from the state, so why should they pay taxes in the state.  However, this meant that a company was free to sell in another state without expense to themselves or the consumer for taxes.  When you look at it from this perspective it is easy to see why consumers turned to online sales, and companies looked to cross state lines.

So, then why is sales tax compliance different for small online businesses?  The biggest hurdle that small businesses face is the method in which to track sales tax.  Sales tax must be tracked at the state, county and municipal levels, with varying rates and exemptions on each level.  An increase complication is that many states have a sales threshold that is made up of a monetary or number of sales value, or both.  Meaning that sales tax must be collected once the company has passed the threshold amount, but only once the threshold has been passed.  Additionally, sales and use taxes are also based upon the buyer’s exemption status.  Sellers will be required to collect and retain exemption certificates to support any non-taxed sales.  Sales tax is due to be remitted by the seller, even if they fail to collect it from the buyer.  Knowing the sales tax rate and when it is applicable is crucial for business owners looking to not pay more out of their own pockets than necessary.  Late filing fees are also a large hardship on small businesses that may miss the deadlines in each area.  It’s also important to note that not every state has sales tax, and not every state that does has adopted economic nexus as their collection basis.  Additionally, some states have destination-based sales tax within each location of the state.  Deducting and applying all of these new data points will increase the time and costs associated with tracking, collecting, reporting and submitting these taxes.  There are entire companies dedicated to assisting businesses with these items.  Additionally, small online businesses will have to bank on their diversity of product to compete with the brick and mortar stores, as they no longer will have the added benefit of reduced cost due to sales tax.

As well as changing the taxation game in the United States, it is believed that Wayfair will pave the way for international sales to be more regulated when it comes to taxation.  We often think of taxation as something that resides solely within our boarders.  Unlike Untied States income taxes, sales and use taxes are not covered by international tax treaties.  This means that a company may be protected from federal taxes based on the treaties established between its country and the United States, but it still may be subject to taxes on the state level.  In 2008, New York implemented what is sometimes known as a “click-through” nexus status.  This created a presumption of nexus for out-of-state sellers who compensated an in-state person based upon commission.  Some states also enacted an “affiliated nexus” statue that creates nexus for companies that have common ownership with an in-state company and engages in activities that expand the marketplace of the out-of-state company.  With the Wayfair case defining online sellers as needing to have “economic nexus” in a state, international sellers may be subject to collection of sales tax.  Additionally, if an international seller has a warehouse in the United States, such as an FBA warehouse, they will now have to comply with the collection and remittance of sales tax.

Both national and foreign companies will need to start reviewing their sales and determine what system they will need to use to properly charge and submit their sales tax.  Additionally, companies must review the regulations for licensing in each state, as the definition of business activity may have changed given the Wayfair changes.

Small business ownership is a good way to take more control of your time and puts more money in your pocket.  But what is the true cost of small business ownership?  Surprisingly, many small business owners are faced with many challenges that may leave them with less time and less money than when they were earning a living working for someone else.

One of the most common mistakes that small business owners make is made within eh first few weeks of starting up their business.  Choosing the wrong entity and/or business structure can severely hurt a small business trying to get on its feet.  While each state is different, the common types of business structures are:  sole proprietorship, partnership, limited liability company, and corporation (C and S are the most common).  It is important to understand who the structuring of your business will affect your tax situation, how you raise money, the paperwork that is needed to be field, as well as your own personal liability requirements.

A sole proprietorship is the easiest to form and gives you complete control over how the business is run.  In most cases, you are automatically considered a sole proprietorship is you perform business activities and do not register as any other type of business.  Sole proprietorships report their taxes on the owner’s personal Federal Form 1040 tax return.  They are also subject to self-employment taxes, and the owner cannot take a W2 wage.  As they are not seen as separate from the owner, all assets and liabilities are also not separate from the owner, and you may be held personally liable for any debt and obligation incurred on behalf of the business.  Sole proprietorships are considered low risk, and a good place for owners looking to start out before creating any more formalized business.

Partnerships are the simplest structure for two or more owners to do business together.  There are two common types of partnerships: limited partnerships and limited liability partnerships.  With a limited partnership, there can be only one general partner and the rest are limited liability partners.  The limited liability partners also have limited control over the company and its decisions.  Profits and losses are passed through to the general partner to report on their personal Federal Form 1040, and any profit is subject to self-employment taxes.  The limited liability partners only pay self-employment on any guaranteed payments they receive.  In the limited liability partnership, the liability is limited to each owner.  This protects all partners from debts against the partnership and the actions of the other partners.

A limited liability company gives the small business owner the benefit of both the corporation and partnership structure.  Limited Liability Companies are designed to protect the owner(s) from personal liability, thereby protecting their assets from lawsuits or debt created in the business.  The profits and losses are passed through to the owner’s personal Federal Form 1040 for taxation.  They are, however, considered to be subject to self-employment taxes.  Each state has different rules regarding the treatment of limited liability companies, so it is important to determine I the regulations of your state will work for your business.

A C Corporation is a legal entity completely separated from its owners.  As a separated entity, it is responsible for its own taxes as well as legal liability.  While this structure provides the most legal protection for the owner, there is also the greatest cost to set up a C Corporation.  They also require the most amount of record keeping, operational process and reporting.  Additionally, they are subject to double taxation.  The profits are first taxed on the corporate level, and then the dividends paid to each owner is taxes on the owner’s personal Federal Form 1040 return.  If an owner chooses to leave the Corporation, he/her shares are simply sold, and the Corporation feels little to no affect.  Raising funds can also be easier, as the Corporation can sell stock.

Sub Chapter S Corporations are designed to avoid the double taxation that occurs in the more traditional C Corporation.  The S Corporation allows for profits and losses to be passed directly to the owner’s or owners’ personal Federal Form 1040 for taxation purposes without being subject to self-employment taxes.  Again, each state has different regulations when it comes to the treatment of S Corporations, and so it is important to understand your own states stance.  The S Corporation is limited in its shareholders to one hundred, and they must all be US Citizens.  It also retains the strict processes and operations reporting that a C Corporation has.  And like a C Corporation, it is easy for a shareholder to leave the company.

As business owners begin to navigate their structure, often underpayment or overpayment of taxes become a key issue.  Many owners are not aware of what income is reportable, participate in barter systems in their first years but do not report them as income, or engage in cash transactions that are not reported to the IRS.  Often owners are unaware of what expenses can be taken against the income, and this can lead to over or under reporting of expenses.  In many states there are taxes associated with the location of the consumer, special licenses and other items that the small business owner may not be aware that they must track or have.  Small business owners often have difficulty complying with the complex tax code that surrounds business ownership because they simply are not aware of it.

It is important to take advantage of deductions and credits available to your business.  It is often hard to keep up with the ever-changing landscape of tax laws and tax reform.  Over forty percent of small business owners say they spend eighty or more hours working on tax and accounting related issues a year, and generally all in the last quarter of the year.  Often it can seem overwhelming to a small business owner, especially those just starting out.  It is important to make sure you start out on the right foot and seek the help of a professional or your state’s business regulatory site to ensure that you are capturing all of the requirements and reporting correctly.

When most people think of foreign accounts, they think of ex-pat living overseas and utilizing banks for the accumulation of their payments.  However, many taxpayers may also be subject to the federal Foreign Bank and Financial Accounts or FBAR reporting without realizing it.  The United States Treasury Department’s Financial Crimes Enforcement Network (FinCEN) 114 form is filed alongside taxpayers’ federal tax return and reports information for those that have a financial interest or signature authority over a foreign financial account.  Financial interest is defined as: directly owning an account; directly owning or indirectly owning more than fifty percent of a corporation’s voting power and/or shares when that corporation owns an account; directly owning or indirectly owning more than fifty percent of a partnership’s profits or capital when that partnership owns an account, or directly owning or indirectly owning more than fifty percent of the voting power, total value or the equity interest or assets, or interest in profits of any entity that owns an account.  It is important to note that disregarded entities that have no other filing requirements may still have an FBAR requirement.  Signature authority is more broadly defined as:  the authority of an individual (alone or in conjunction with another) to control the disposition of money, funds, or other assets held in a financial account by direct communication (whether in writing or otherwise) to the person with whom the financial account in maintained.  Here it is important to note that officers and employees may delegate the filing of Form 114 under this definition to another, but they still remain personally liable for any delinquent filing.  It is important to know what accounts your company has stakes in if you have signature authority over any company accounts.

The FBAR was created to uncover funds being hidden offshore.  And while it has been around for quite a while, the Internal Revenue Service has not seriously enforced it until recently.  For most filers, you will be required to complete Part III of Schedule B of Form 1040 and Form 8938 as part of your tax return, as well as Form 114 which is filed separately.  Bear in mind that the FBAR and other foreign reporting forms are not taxation related forms.  They are simply balance reporting forms so that the IRS is aware of overseas monies.

Individuals, corporations, partnerships, limited liability companies, trusts and estates are all subject to foreign reporting if they meet the threshold requirements.  The current threshold amount for reporting is $10,000 of your combined foreign accounts at any given time during the calendar year.  Heavy penalties are enforced if a taxpayer meets these requirements but fails to file the proper form(s), even if they did not know that they had a requirement to file.  These fines can be anywhere from $10,000 to $100,000 or fifty percent of the account balances, depending on the reason for not filing and the amount of your account balances at the time of the violation.  Over the last ten years, after the introduction of the penalties, the filings for FBAR reporting increased from two-hundred—eighty-thousand to over one million.

As many taxpayers were unaware that they had filing requirements in accordance with the Foreign Account Tax Compliant Act (FATCA), in 2009, the IRS established the Offshore Voluntary Disclosure Program which allowed taxpayers to alleviate civil penalties and lower the risk of criminal prosecution for failing to disclose offshore accounts.  It is important to note that the OVDP is different than filing a delinquent FBAR and/or Form 8938 and understanding which is more beneficial to the taxpayer is crucial before applying.  The OVDP is used generally by taxpayers that have criminal tax exposure with respect to non-willful noncompliance of their tax situation.  Non-willful tax violation means that you did not intentionally try to evade your tax reporting, may not have been aware of your reporting requirements, may not have been aware that your aggregate total in your foreign accounts reached the threshold, or you did not properly convert the account to the USD value and understand that there it met the filing requirements.  Other violations include not understanding which accounts fall under the aggregate account definition, and or which accounts you have signature authority over.  And while filing the OVDP can mean that you can avoid some of the more severe penalties, it can mean that the taxpayer is found to have underreported their foreign income and taxes can be due, including “failure to file” and “failure to pay” penalties and interest, as well as the “in lieu” penalty.  In exchange for not being penalized criminally, the filer agrees to pay back the penalties.  A taxpayer does have the option to opt-out of the OVDP, but that means that the IRS can come after you for criminal penalties, although this is rare is you have substantial evidence that you non-willfully failed to report.  If you are facing OVDP penalties of fifty percent or greater of your account values, then opting-out may be an option.  Filing delinquent FBAR, in these cases, may mean paying less in tax penalties.

Recently, the IRS announced that it is closing the OVDP.  Although the program was successful in incentivizing taxpayers to report their foreign transactions, the use of the program has steadily declined in recent years.  More and more taxpayers are utilizing proper reporting techniques, and this led to only 600 filed cases in 2017.  However, the closing of the program should not lead to the assumption that the IRS will stop combating offshore tax evasion and noncompliance issues.  Historically, the OVDP has evolved over the years, and a new version may manifest in the coming period.  Alternatives to the OVDP are currently available to taxpayers wishing to disclose.  Taxpayers are encouraged to utilize the IRS Streamlined Voluntary Disclosure Submission Process, the IRS Criminal Investigation Voluntary Disclosure Program, the Delinquent FBAR, or the Delinquent International Information Return.

Due to the complexities involved with each of these filings, it is advisable to seek the advice of an experienced OVDP attorney prior to making any disclosures.

When we are working, taxes are a part of daily life and influence the considerations that we take in our spending habits.  Once we start thinking about retiring, we often forget to add in taxes as a component to our thought process.  It is important to understand your tax situation in retirement prior to retiring so that you will be ready when the time comes to pay on the taxes due.

1. Social Security

When we think about retirement, Social Security tends to be the first thing that comes to most people’s minds.  An individual’s Social Security is funded by reducing a portion of their paychecks as taxation payable towards the Federal Insurance Contributions Act, better known as FICA taxes, as well as their employer paying in matching taxes from their own funds.  For the self-employed, both sides of FICA are paid through self-employment taxes based upon the Self-Employment Contributions Act of 1954 (SECA) by the self-employed individual.  Social Security was originally created through the Social Security Act of 1935, to ensure basic rights to each person as they aged, became unemployed, and for under working age children.  While it has gone through several changes since President Roosevelt first signed it into law, the idea behind Social Security remains the same.

Up until 1984, Social Security benefits remained untaxable.  This was different than private pensions, in that most private pensions are partially taxable.  Private pension benefits are taxable to the extent the pension recipient is generally liable for the portion of the benefits that (s)he did not her/himself contribute.   This includes the employer portion of the pension contributions, as well as interested earned by the funds.  The 1983 Amendments to the Social Security Act, challenged the taxability of Social Security benefits by determining that Social Security was also not funded solely by the individual employee.  Additionally, many individuals were receiving benefits over and above the amount that they themselves contributed due to Social Security’s program operating on the insurance principle.  In the 1983 Amendments, Congress approved that Social Security up to fifty-percent of the value of the benefit could be potentially taxable.  In 1993, as part of the Omnibus Budget Reconciliation Act, a secondary threshold was created that meant that up to eighty-five percent of Social Security benefits could be potentially taxable.  The intention here was to bring Social Security closer in line with private pensions, but only for the higher-income beneficiaries.

Knowing the income thresholds that will push your Social Security into a taxable position, will be important as you approach retirement.  The higher your income, the larger the percentage of Social Security benefits you will have to pay taxes on.    The income used in the threshold calculation is known as your adjusted gross income and include pensions distributions, retirement account withdrawals from taxable retirement (other than Social Security), and tax-free interest; as well as any earned income you may have.  This makes Roth accounts a good option for retirement planning,

2. Traditional and Tax-deferred Accounts Versus Roth Accounts

There are may ways of thinking and planning for retirement account funding, much of which will depend on where you are in your working life, as well as retirement goals and needs. As this is a brief overview of the three general types of retirement accounts, discussions on which plan type is right for you should be reviewed with your retirement plan broker and tax accountant.

Traditional individual retirement accounts (IRA) are funded by contributions made with after-tax dollars that allow for tax-free growth.    The contributions made to these accounts are potentially deductible on your income tax return.  These are generally utilized to supplement employer-sponsored plans that may not accumulate enough to give you the retirement savings you need.

While you are working, tax-deferred retirement accounts provide the benefit of reducing your taxable income while you save for the future.  Contributions to these types of retirement plans allow you to contribute directly from your wages or self-employed income before taxes.  However, once you have retired, any distribution from these funds becomes taxable.  The idea is that at the point you begin to withdraw these retirement funds, you will be in a lower tax bracket than when you were working.  At age seventy and a half, the Internal Revenue Service requires you to take a certain amount of funds out of your account each year.  The penalty for not taking your required minimum distribution is fifty percent of the amount you should have withdrawn.

On the flip-side, distributions that you take out of your Roth retirement accounts are tax-free.  A Roth is an after-tax contribution funded account.  Most other retirement contributions are either made with pre-tax dollars or are deductible against taxable income.  Roths are not.  So, while you will not see the benefit of a Roth contribution while you are working, qualified withdrawals from the account in retirement are tax-free (as long as the account has been open for five years or more).  Roths also lack the required minimum distribution portion that non-Roth accounts have.  Roths also allow you to withdraw the contribution amount at any time and for any reason, without penalty.

3. Withholding and Estimated Tax Payments

When we are working for an employer, most of our annual tax liability gets paid in the form of federal withholding on our paychecks.  Withholding is calculated using the IRS tables and based on the information on your Form W4.  While many of us would prefer to have those extra dollars in our pockets each month, it does reduce or can potentially wipeout the taxes due in April.  In this way, paying a little in each pay period can be beneficial to a large tax hit in April.  Once we retire, however, these payments are no longer made through our wages.  With the IRS requirement that says that you must make payments throughout the year if you are going to owe one-thousand dollars or more, knowing your potential tax ahead of time is crucial.  You must ensure that you pay at least what you owed in the prior year, or one-hundred and ten percent if your adjusted gross income will be more than one-hundred-fifty-thousand dollars.  This will reduce the underpayment penalty but may not cover the taxes you end up owing in the current year. One way to achieve this pre-payment is to continue your withholding through your retirement payments.  Another is to make estimated tax payments throughout the year in quarterly installments.  These can be made through the IRS website or via check with a voucher you will receive with your annual tax return if requested.  The calculation of what you may owe can be complex and it is best to seek the advice of a tax professional.