Deducting Business Losses

Even if you own 100% of a business, be it a sole proprietorship, LLC, partnership, or S corporation, you can't deduct losses from the entity unless you can show you materially participate in the business.

That is, you're involved in the activity in managing or working in the business. Showing up once a week to review the books for two hours won't qualify as material participation; participation must be substantial.

There are several ways to show material participation, but most business owners will pass the test using the more than 500 hour rule. In Alfred A. Iversen et ux. (T.C. Memo. 2012-19) the taxpayer was the founder of a large manufacturer of surgical and medical equipment in Minnesota. He also owned a working cattle ranch with 14,000 owned and 28,000 leased acres operated as an LLC. The ranch generated losses and the taxpayer claimed he materially participated in the operation. The IRS claimed the taxpayer did not, and disallowed the losses. The taxpayers lived in Minnesota and flew to the ranch either alone or with guests.

The Court noted participation in an activity may be shown by any reasonable means, including calendars, appointment books, or narrative summaries identifying work performed and the approximate number of hours spent performing the work. Contemporaneous daily time reports, logs, or similar documents are not required if other reasonable means exist of establishing a taxpayer's participation.

Neither of the taxpayers maintained a log, diary, notes or other record of the work performed. The taxpayers claimed they spent 2 to 3 hours a day on telephone calls, emails, and fax communications with the ranch manager. Telephone records introduced did not support that claim. Airplane logs indicated few trips during one of the years at issue and the trips were only for a day. Moreover, a family member went along.

The Court also noted that the fact that the airplane flights were paid for by the taxpayer's corporation, not the ranch, indicated the time spent at the ranch often and primarily related to the affairs of the corporation. In addition, the presence at the ranch of a full-time paid ranch manager for most of 2005 and 2006 disqualifies much of the taxpayer's time working on ranch activities from counting under the facts and circumstances test (an alternate test for material participation). The Court concluded the taxpayer failed to show he materially participated in the activity. 

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Tax Tips for the Self-employed

There are many benefits that come from being your own boss. If you work for yourself, as an independent contractor, or you carry on a trade or business as a sole proprietor, you are generally considered to be self-employed.

Here are six key points the IRS would like you to know about self-employment and self- employment taxes:

1. Self-employment can include work in addition to your regular full-time business activities, such as part-time work you do at home or in addition to your regular job.

2. If you are self-employed you generally have to pay self-employment tax as well as income tax. Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. You figure self-employment tax using a Form 1040 Schedule SE. Also, you can deduct half of your self-employment tax in figuring your adjusted gross income.

3. You file an IRS Schedule C, Profit or Loss from Business, or C-EZ, Net Profit from Business, with your Form 1040.

4. If you are self-employed you may have to make estimated tax payments. This applies even if you also have a full-time or part-time job and your employer withholds taxes from your wages. Estimated tax is the method used to pay tax on income that is not subject to withholding. If you fail to make quarterly payments you may be penalized for underpayment at the end of the tax year.

5. You can deduct the costs of running your business. These costs are known as business expenses. These are costs you do not have to capitalize or include in the cost of goods sold but can deduct in the current year.

6. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Deducting Un-reimbursed Employee Expenses

You can deduct on your personal return business expenses that you're not reimbursed for by your employer or by a partnership in which you're a partner. But that's only true if you would not have been reimbursed because of a policy by the business. 

In Peter A. McLauchlan (T.C. Memo. 2011-289) the taxpayer paid various expenses (e.g., advertising, home office, automobile, travel, meals, entertainment, cell phone, professional organizations, continuing legal education, State bar membership, supplies, interest, banking fees and legal support services) in connection with work at the partnership. The partnership reimbursed him for over $60,000 of expenses for each of 2005 and 2006. The taxpayer contended, however, that he paid over $100,000 of partnership expenses in both 2005 and 2006 for which he was not reimbursed.

He categorized and claimed these expenses on Schedules C. Partners in the firm were required, under the partnership agreement, to pay expenses for business meals, auto, travel, entertainment, conventions, and continuing education, collectively called indirect expenses. Indirect expenses were reimbursable under the partnership agreement if approved by a managing partner. The firm had a written reimbursement policy that specifically provided for reimbursement of certain indirect expenses include reasonable travel expenses related to client maintenance and development. As a matter of routine practice, the firm would reimburse indirect expenses that were not provided for in the written reimbursement policy. The firm did not have a limit on the amount for which a partner could be reimbursed. Reasonableness, rather, was the overarching standard for approving reimbursement of indirect expenses. The firm would deem an expense unreasonable if it was personal, excessive or not in the firm's best interests.

The Court noted that the firm routinely reimbursed most of the expenses the taxpayer claimed. Moreover, the firm had no set limit on the amount of expenses for which it would reimburse a partner. The Court found the taxpayer was not required under the partnership agreement or by routine practice to pay such expenses. In addition, the taxpayer failed to point to any specific expense for which the firm denied him reimbursement. The Court disallowed the expenses.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Vendor Co-Op Funds

Many manufacturers and wholesalers provide funds to their distributors and retailers for advertising, demo equipment, point-of-purchase displays, etc. Generally, it's free money. There may be strings attached such as how the money can be used, that products from competing suppliers can't be advertised on the same page, etc., but for the most part the restrictions aren't onerous.

Make sure you know the rules. The amount you receive is often based on your volume with the supplier over a 3, 6, or 12-month period. You usually have a certain amount of time to use the money and file a claim. Make sure someone is in charge of the program so you don't lose out.

Finally, keep in mind that any amounts you receive constitute taxable income. But, of course, that will be offset by the cost of the ads, etc. If you're a manufacturer or supplier, you might consider instituting such a program for dealers.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

No Bad Debt Deduction for Cash Method Taxpayers

It's a well-settled issue, but some business taxpayers still think you can take a deduction for an unpaid invoice if you're on the cash method of accounting. You can't. And the reason is simple when you think about it. Under the cash system you only pay tax on money you receive. Since you never paid tax on the money, you can't take a deduction. (You're still getting a deduction for your cost of goods sold, labor, etc. on the return.) Under the accrual system you're reporting income even if you don't receive the cash or check, so if you can't collect, you've got a bad debt deduction.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.

Turn Your Home Office Into A Tax Saving Machine

A home office deduction is allowed for those who work out of their home, but it can be tricky to understand which expenses to track and who should record and pay for the expenses.

Proper tracking and recording is key for maximizing any deduction - particularly the home office deduction.

Here is a checklist you can use to help with tracking and recording your home office expenses. 

Personal Expenses for Your Home Office

A great tax benefit that comes with qualifying your home office is that a portion of your personal expenses to maintain your home becomes deductible. 

Some of these expenses are not deductible otherwise.  But even for those that are already deductible, such as your mortgage interest and property taxes, the way in which the home office calculation works, your deduction for these items is not subject to the limitations that otherwise apply. 

Track and record (and pay) these expenses personally:

• Mortgage interest
• Property taxes
• Homeowner's insurance
• Utilities
• Security
• HOA dues
• Cleaning
• Pest control
• Other expenses that relate to the running of your entire home

Caution! Certain expenses are non-deductible.  This includes pool maintenance, lawn maintenance, landscaping and the first phone line into your home.

Business Expenses

Business expenses for your home office are expenses that your business has regardless of where your office is located. 

Have your business track and record (and pay) these expenses directly:

• Supplies
• Equipment
• Furniture
• Separate business phone line
• Repairs made directly to the home office
• Other expenses that are 100% business use

Claim Your Home Office Deduction

The home office is one of the best types of deductions because it turns expenses you already have into deductible expenses. This means it is eliminating tax and that is the best type of tax planning

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.  

How To Handle Your Start-Up Expenses

One of the great benefits of having an entity is that it is separate from you.  This allows for great tax and asset protection benefits.  

One of the key rules of keeping your entity separate from you is to not commingle funds.  This means the entity pays for its expenses with its own funds.  

The catch-22 is the entity cannot set up a bank account to pay for its own expenses until after it is formed and the formation fees must be paid before the entity can be set up.

How Do You Handle this Situation?

In this situation, personal funds must be used to pay the formation fees, and other expenses, until the entity's bank account can be set up.

 There are a few things to keep in mind when you use personal funds for business expenses:

Capture It in Your Personal Bookkeeping

Your personal bookkeeping is the starting point since personal funds will be used. 

There are a few ways the personal funds can be coded in your personal bookkeeping.  For example, the funds could be considered a capital contribution or a loan to your entity.  Let's assume that they will be considered a loan.  

When you code the expense(s) in your personal bookkeeping, code it to a current asset account that is used only for tracking expenses for your business.   In my bookkeeping, I use the account name "Reimbursements Due from Entity XYZ."  

The key is making sure that this reimbursement account is an asset account.  This will ensure that if you have not been reimbursed by your entity for these expenses you paid for personally, there will be a balance in this asset account.  If your entity has reimbursed you in full, then the balance will be zero.  

Capture It in Your Entity's Bookkeeping

Next, you need to have your entity reimburse you.  The amount your entity owes you is the balance in the asset account in your personal bookkeeping from above.  

To complete this step, have your entity make a payment to you for the amount of the reimbursement due.  When your entity makes this payment, it will code the payment in its bookkeeping to the appropriate account.  

This is a key step because the reimbursement is how your entity records the expense on its books.  It's important to make sure the reimbursement gets done before the end of the year so your entity can capture the expense in the appropriate tax year.

If your entity doesn't have the funds to reimburse you, then you should consider charging interest or categorizing the expenses paid personally as a contribution to your entity rather than a loan. 

When your entity reimburses you, be sure to code it to the asset account you use to track your reimbursements in your personal bookkeeping.  This is the "Reimbursements Due" account described above.  

Use this Method for all Personal Funds Used for Business Expenses  

While the most common instance of using personal funds for business expenses is during the formation phase, you may find that there are other times when you must use personal funds for business expenses.

When you run into this, use this same method.  Capture the expenses in your personal bookkeeping when you pay the expense and then have your entity reimburse you.

A quick way to check if your entity has properly reimbursed you is the reimbursement account on your personal books should be zero.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form.   

If You Want to Change Your Tax, Change Your Facts

One of the most powerful ways to make the tax rules work for you is to change your facts. This concept applies in most developed countries because the tax law is written to favor specific facts. 

Do you know someone who is always sharing the write-off of their most recent meal (trip, vehicle, cell phone, gadget, etc.)? Do you wonder if what they are doing is cheating or legal? 

With the right set of facts, any of those items can be legal tax deductions. 

That's why when I meet with a new client, I want to know their facts first. Then, I can determine how to change their facts to reduce their tax.

What are these facts?

The facts I'm referring to here are usually surrounding where your money comes from and where it goes.

• Do you own a business?
• Do you own investment real estate?
• Are you an employee?
• Are you self-employed?
• How much time do you spend in your business?
• How much time do you spend in your investing?
• What is your role in your business?
• What is your role in your investing?
• What investments do you have? 
• What expenses do you pay personally? 
• What expenses are paid by your business or investing activity? 

What is deductible for one person may not be deductible for another person. This is because one person's facts can support a particular deduction whereas another person's may not. 

If you don't like your tax, change your facts.

A few years ago, a client asked me if he could deduct his travel to a particular state. He and his family enjoyed spending time and traveling there frequently. At that time, he didn't have a business reason to travel to that state and his business was not set up to conduct business in that particular area. 

I went over the specific rules with my client that covered what he needed to do in order to meet the requirements to deduct the travel in his business. I also shared with him how he could deduct the travel expenses for his spouse and children. 

A few months later, my client tells me about a very profitable deal he now has in the state and he provided me with all of the documentation we discussed to support his deductions. 

My client jumped in and changed his facts. It led to increasing his deductions, reducing his taxes and making more money! In order to meet the rules, he had to conduct legitimate business in the state. He did and he was very successful at it.

How can you change your facts?

Any time you have cash come in or go out, there's an opportunity to change your facts. 

Should you receive the income personally or should your business receive the income? 

Are your investments helping your tax situation or should you explore new investment strategies?

Are your expenses personal or do they meet the rules specific to your situation that make them deductible?

Are you willing to change your facts?

If you have any questions about changing your fact, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

IRS Goes Where The Money Is

The outlaw Willie Sutton stole an estimated $2 million over a 40-year career robbing banks -- and scored the ultimate "success" in his business, living long enough to die of natural causes. Sutton always carried a pistol or Tommy gun with him on jobs, declaring "you can't rob a bank on charm and personality." But the gun was neverloaded, because, as he said, someone might have gotten hurt! And he became legendary, ironically, for something he never actually said. According to the story, Sutton was asked why he robbed banks -- and replied "because that's where the money is." But in his 1976 autobiography, Where the Money Was: The Memoirs of a Bank Robber, he confessed that credit for the line belongs to "some enterprising reporter who apparently felt a need to fill out his copy."

What does a depression-era bank robber have to do with taxes? Well, the IRS estimates that outlaw taxpayers cost the Treasury $385 billion per year in uncollected taxes -- roughly 15% of the amount they believe is due under current law. So they work hard to close that gap. In FY 2011, the IRS employed over 22,000 revenue officers, revenue agents, and special agents. They conducted 391,621 "field" audits and 1,173,069 less-intensive "correspondence" audits. They filed levies on 3.7 million taxpayers and filed over a million liens. But they can't turn over every rock. So how do they case their targets?

Earlier this month, the IRS released their FY 2011Enforcement and Service Results revealing how likely you are to be audited. And even Willie Sutton would have appreciated the IRS's "M.O.":

• If you make less than $200,000, your overall audit risk is only about one in a hundred. (Of course, that average encompasses a range of possibilities. If you run a sole proprietorship in a cash-heavy business like takeout pizza, your risk may be far higher.)
• If you make over $200,000, your overall audit risk rises to about one in twenty-five. Obviously, the IRS sees more opportunity in chasing higher income earners.
• If you pull down over $1 million, your audit risk rises again to one in eight. Welcome to the 1%!

The IRS likes targeting entertainers, athletes, and other celebrities, too. Sure, it sets a high-profile example for the rest of us. But it's also (spoiler alert) where the money is. Take Hollywood trainwreck Lindsay Lohan, for example. Google her name, and you'll usually find it followed by "failed another breathalyzer test" or "missed her court-appointed community service." But last week, Lohan made a different kind of headline. That's right, the IRS filed a lien against her home seeking $93,701.57 in upaid taxes from 2009.

Where does that all leave us as we move into this year's tax season? Our job is to help you pay the minimum tax allowed by law. But we know the IRS is out to challenge us. So we don't cut corners. We give you good, solidplanning. That way, even if you do lose the "audit lottery," you'll feel safe knowing your savings are court-tested and IRS-approved.

If you have any questions about this topic, tax law changes, business tips, or how to become a client, please call us at 954-591-8290 or use our Contact form. 

Valuing Rental Property

When you're buying a house the appraiser may use several methods, but the selling price of comparables in the area is usually the one that determines the value. That's not true for investment properties such as apartment buildings, office buildings, etc. For these properties the cash flow from the property is what generally determines the value. While location and certain other factors go far in determining the cash flow, management can be a critical factor. A good manager can buy a property cheaply and turn it into a cash cow by getting the building fully leased, increasing rents, cutting costs, etc.