Huddleston Tax Weekly

How would you like to be able to deduct your child’s allowance, school clothes and piano lessons?  Seem too good to be true?  As the owner of a legitimate business, if you hired an assistant to help you organize files or clean your office, you would pay him or her a salary and deduct the wages.  The same is true for your children.

Hiring a typical employee can be very expensive.  In addition to paying an employee a salary, you must submit payroll taxes of 15.3% on their earnings.  However, if your business is not incorporated, and your child is under 18, you do not have to withhold these taxes.  In fact, you could pay your child up to $5,700 in 2009 without the child being responsible for income taxes, and your business would get to deduct that $5,700.

There are a few rules you need to follow to make your children legitimate employees.  First, only hire your children to do appropriate work for his or her age and skill set.  You probably would not expect your child to do the same level of work that you do.  

Second, pay him or her a reasonable wage for the duties performed.  A good idea would be to call a staffing agency and inquire about how much it would cost to hire someone to perform your child’s duties.  Then, pay your child $1 or $2 less per hour.

Third, keep excellent records.  Create a daily time card for your child and fill it out with the hours worked and the duties performed. 

As long as your child is performing reasonable work for reasonable pay, and you are keeping great records, you should be able to deduct thousands of dollars every year. 

For advice on your specific situation, consult your tax accountant.

If you are like most people, you have probably been confused about who you should hire to help you prepare your tax return.  Just as doctors have areas of expertise, so do accountants.  If you chose the wrong accountant, it could cost you thousands in missed or incorrect deductions.  If you own a small business, here are some of the questions you may want to ask a potential accountant:

• What are your credentials?  Look for someone with a special designation, such as CPA (Certified Public Accountant) or an attorney.
• Do you practice tax accounting full time?  The answer should be yes.
• How many years have you been in practice?  You don’t want someone new to the accounting profession experimenting on you.
• What computer software do you use to prepare returns? If the returns are handwritten, you should probably leave.
• What are your fees?  Cheap is not necessarily better.  You often get what you pay for!
• Do you have any references from clients similar to me?  You should not expect the accountant to give out names of clients, but he or she should have some happy clients who would be willing to speak to you.
• Do you consider yourself to be aggressive, assertive or somewhere in the middle? 
• Do you specialize in small business tax returns?  Hopefully, the answer is yes!
• What do you do after tax season?  Some good answers would be that the accountant does other accounting work, markets for new customers and takes tax courses.
• Do you provide any tax courses or tax planning during the year?  The more the better!
• How many other clients like me do you have?  The accountant should have at least 10 clients similar to you and your situation.

Property acquired for business use, rental use, or any other income producing use that is expected to last more than one year cannot be deducted as a business expense all in the year it was aquired.  This is where depreciation comes into play.  You must deduct the expense over the usual life of the asset.  The useful life of an asset is defined by the IRS and gets deducted on form 4562. 

For property to be depreciated on your tax return you must own the property, it must be used on your business or rental activity, it must have a determinable useful life, and it must be expected to last more than one year.  Some examples of depreciable property are, buildings, computers, autos, copy machines, furniture, and large equipment.  There are some things that are not depreciable, such as land, property placed in service and disposed of in the same year, and some intangibles.  If you have a home that is used in both business and personal, then only the business portion can be depreciated. 

In order to compute deprecation you must know when the asset was placed in service, what the basis of the asset is (usually the purchase price of the asset), and the appropriate depreciation method and usefull life.  When an asset was placed in service isn’t always the date it was purchased.  If you buy a car for your business on June 15th, but don’t start using it in your business until August 1st, then you must start depreciating it as of August 1st, not June 15th.  Also, if you have a rental house then depreciation should start as soon as it is available for rental, even if it has not yet been rented. 

There is a way for some taxpayers to elected to expense all or some of an assets cost in the year of purchase using Section 179.  Section 179 allows you to deduct all of the depreciation up front rather than spreading it over the useful life.  Section 179 may only be taken on business assets, not rental assets.  

For more information on Section 179 and general deprecation you should consult your tax professional.

A sole proprietorship is undeniably the easiest, lowest-costing entity to form and manage.  Here are some of the advantages of a sole proprietorship:

1. Simplicity - This is by far the least complicated type of entity to form and administer.  If you have no employees, the only form you need to file with the IRS is Schedule C on your 1040 tax return.

2. Low costs of formation - It  may not cost anything to begin operations as a sole proprietor, unless you wish to have employees.

3. Control - Since there can only be one owner of a sole proprietorship (you), there is no hassle with other owners or partners.

4. Flexibility - A sole proprietorship is easy to sell or to end.

5. Great tax benefits - As the owner of a sole propriertorship, you are entitled to the many tax benefits of operating a small business.

Unfortunately, along with the ease and simplicity of operating as a sole proprietorship come the following disadvantages:

1.  Unlimited liability - This is undoubtedly the sole proprietorship’s greatest disadvantage.  If you are sued for any business problem or if your business incurrs any debts, you are personally liable.  Therefore, if there is any chance someone could sue you, if you have any employees, or if you have substantial assets to protect, you should definitely not operate as a sole proprietor. 

2. No managerial oversight - By definition, a sole propriertorship has only one owner.  So, there is no partner or board of directors to provide business advice about decisions.

3. Difficulty raising money - A sole proprietor generally has more trouble securing loans for the business, since the owner’s assets are collateral.

4. Low stability - if the owner dies or becomes disabled, there may be no one else who could run the business.  Therefore, the business could end abruptly at any time.

Overall, a sole proprietorship is wonderfully simple to begin and to operate, but the unlimited liability potential can outweigh these benefits.  The only people who should consider this entity for their business are those who have almost no possibility of liability problems, no employees and few assets that need protection. 

Probably those who would benefit most from this choice of entity are people with a home-based businesses, like network marketers or free-lance writers.  However, if your tax accountant or attorney feels that you should chose another entity, you should take his or her advice.

When you use your car or truck for business, generally the expenses associated with that are deductible as business expenses.  You can deduct the auto expenses for business when you are traveling from one work location to another, visiting customers, attending business meetings away from your regular workplace, or getting from home to a temporary workplace.  You should remember that auto expenses related to travel between your home and your regular place of work are considered commuting expenses and are not deductible.

There are two options for deducting auto expense on your tax return.  You can choose to use either the standard mileage rate or actual expenses. 

The standard mileage rate can be used to figure the auto deduction if the car or truck is owned or leased.  When your auto is leased and you use the standard mileage rate, it must be used for the entire lease period.  The standard mileage rate is adjusted annually by the Internal Revenue Service.  For 2009 the rate is 55 cents per mile.  There are a few cases when you are not allowed to use the standard mileage rate and that is when you use the car for hire, use more than five cars at a time, claim depreciation on the auto, or are a rural mail carrier.

The actual expense method includes deducting expenses for depreciation, gas, insurance, repairs, oil changes, registration, etc.   In the case of the actual expense method, if your business use is less than 100% you must allocate the expenses between business and personal use. 

No matter which method you choose it is important to keep good records of your expenses and your miles driven both personal and business.  It is important to keep a mileage log and the receipts for gas, repairs, etc. If you have questions on whether or not an auto expenses is deductible or about which method is better for your situation then please contact your tax advisor.

Jessica Chisholm, CPA
Seattle/Bellevue Tax Accountants

Taxpayers must report all income they earn and receive in a year on their tax return.  Often times, however, people neglect to report several types of miscellanous income.  The types of income that are often not reported are self-employment income where no 1099-misc is received, bartering income, gambling winnings, and prizes. 

A business owner is only required to send an independent contractor a 1099-misc if the work they did for them exceeds $600 in compensation.  This does not mean that the independent contractor does not need to report the income on their tax return if they do not receive a 1099-misc.  Any income needs to be reported, no matter how small the amount.

Bartering income is also often times not reported.  If you are a small business owner who trades services with another business owner, this counts as income and must be reported as such on your tax return.  For example, if you are a landscaper and you agree to landscape your Accountants yard in exchange for bookkeeping services, then the value of the bookkeeping services are taxable income to you.

Gambling winnings from such things as lottery tickets, horse racing, casinos are also taxable.  Just because you are not issued a W-2G does not mean you are exempt from reporting your winnings.  Gambling losses may be deducted if you itemizes, but only to the extent of winnings.

When you win prizes from things like game shows and contests, the cash value of the prize is considered taxable income to the person who won.  This should be reported as other income on line 21 of your 1040.

If you ever have a question about what income should be reported on your tax return you should discuss it with your tax advisor to make sure you have correctly reported all taxable income for the year.

The first time homebuyer $8,000 tax credit has been extended beyond the orginal November 30th deadline.  First time homebuyers now have until April 30, 2010 to entering into a binding contact to purchase a home and must close on that home by June 30, 2010.  For qualifying purchases of principal residences, first time homebuyers can claim this credit on either their 2009 or 2010 tax return.

There is also a new credit for homeowers looking to buy a new home.  If you have lived in your home for 5 consecutive years during the last 8 year period ending on the date of the new home purchase, then you may qualify for a $6,500 tax credit.

People with higher incomes may now also qualify for one of these credits when they were not able to before.  The new phase out for single filers starts with a modified adjusted gross income of $125,000-$145,000 and for joint filers at $225,000-$245,000.

These new credits are available starting after November 6th and have several new restrictions applied to them.

1.  Purchaser must attached the settlement statement to their tax return.

2.  No credit is available if the house purchase price exceeds $800,000.

3.  Purchaser must be at least 18 years old.

4.  A dependent is not eligible for the credit.

5.  The new law gives the IRS broader authority to deny the credit claims without first having to audit the return.

Remember that these credits only apply to the purchase of your principal residence.  If you have questions about whether or not you qualify for one of these credits, please consult with your tax advisor.

When you own your own business and you are a sole proprietor, you can set up a retirement plan for yourself and your employees if you have them.  Once you have set up a retirement plan, the contrbutions that you make for yourself are deductible on your tax return.  There are a few times of retirement plans that the IRS allows for sole proprietors, such as Simplified Employee Pension plans (SEPs) and Savings Incentive Match Plan for Employees Individual Retirement Account plans (SIMPLE IRA).  Which plan you choose is up to you and you should consult your tax or investment advisor for more information.  Generally these retirement plans are such that the current contributions are deductible and are not taxable to the employee until they are distributed.

If you have net profits from either a Schedule C or a Schedule F, then you may qualify for a deduction of your contributions to your retirment plan.  The deduction is the total cotributions to the plan.  You deduct this from your gross income on your tax return.  There are limits on this deduction.  There are also maximums that you are allow to contribute to self-employed retirement plans.  For more information about self-employed retirement plans you can see IRS Publication 560 or contact your tax professional.

When an officer of an S Corporation performs services for the corporation and are entitled to receive payment for those services then their compensation should generally be considered wages.  Under the Internal Revenue Code, corporate officers are specifically included in the definition of an employee for federal tax purposes.  Because of this, when an S Corporation officer receives these payments for services, they should be treated as wages and not distributions of cash, property, or as loans to shareholder.

The IRS wants to make sure that officers of S Corporations are not avoiding paying employment taxes on officer compensation by treating it as a distribution or loan rather than as wages.  Courts have repeating found that S Corporation officers who provide more than minor services to the corporation and receive payments need to be treated as employees whose wages are subject to federal employment taxes.  There is a exception to this provided by the Treasury Regulations for officers who do not perform any services or provide only minor services that do not entitle him or her to compensation.  These officers should not be considered employees.

 

The IRS requires that S Corporation officers that should be treated as employees take a “reasonable salary” each year for their services.  There is not guidance in Codes or Regulations that say what a “reasonable salary” is and the courts have ruled that it depends on the facts and circumstances of each case. 

 

The following are some of the factors that have been considered by the courts in determining a “reasonable salary”:

 

-Experience

-Responsibilities

-Time devoted to the business

-Wages paid to non-shareholder employees

-Wages paid by comparable businesses for similar services

 

If you need help determining what a reasonable salary is for your business it is best to consult your tax advisor.

Jessica Chisholm, CPA
Seattle/Bellevue Tax Accountants

Is it possible that your business is actually just considered a hobby by the IRS?  Is it possible that your hobby is actually a for profit business in the eyes of the IRS?  IRS code section 183 limits deductions that can be claimed when an activity is not actually engaged in for profit.  This is often times referred to as the “hobby loss rule”. 

When you have a business you are generally able to deduct ordinary and necessary expenses needed to engage in your trade or activity in order to produce income.  If you are generating a lot of expenses and little to no income then it is possible the IRS will consider your business to be just a “hobby”.  The following factors may help you determine whether or not your activity is a for profit business.

1.  Do you put enough time and effort into the activity so that it indicates your intention to make a profit?

2.  Do you depend on income from the activity?

3.  Were any losses that were incurred due to circumstances beyond your control or during the start-up phase of your business?

4.  Have you made attempts to improve profitability?

5.  Do you have the necessary knowledge to run a successful business?

6.  Does the activity make a profit in some years?

According to the IRS an activity that has made a profit in at least three of the last five years, including the current year, is a for profit activity.  If your business has never shown a profit or only shows a small profit every few years, then it is very possible that the IRS could disallow some of your business deductions under Section 183. 

If your activity is shown to not be a for profit business then the deductions that will be allowed cannot exceed the gross income of the activity.  Deductions for a hobby are taken on Schedule A (itemized deductions) of your form 1040. 

Please consult your tax advisor if you have questions about whether or not your business is a for profit venture or a hobby.