Is your Schedule C business a Hobby in the Eyes of the IRS?

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by April Thiel, CPA, Senior Manager at Gordon Advisors, P.C.

 

 

Many small businesses are organized as a sole proprietorship and file a Schedule C on the owner’s personal 1040. What happens when your expenses exceed your income and you incur losses? Can you still claim those tax deductions? The answer is; you can deduct them if you can show that you are truly running a business and not merely engaging in a hobby.
Taxpayers are allowed to deduct ordinary and necessary business expenses. In order for the IRS allow the deduction as a business expense, you need to make sure the activity or business is considered “engaged in for profit”. You need to make a profit in at least three of the last five tax years in order for your business to be considered for profit and not merely a hobby. In addition to that requirement, here are a few (not all inclusive) factors to consider:

Do you depend on the income from the activity?
Do you conduct business in a professional way? (A website, business cards, letterhead, etc.)
Does the time and effort you put into the activity indicate your intention of this being a business?
Do you expect to make a profit?
Do you have the necessary knowledge to be successful in the business?
Do you treat it as a business?

The IRS is trying to ensure that you are not merely turning what is a hobby, into a deductible loss. Here are a few ways you can help substantiate your legitimate business expenses: keeping good records, hiring some professionals, write a business plan, keep business and personal expenses separate & ensure your income and expenses are matched properly. The IRS scrutinizes this area intensely and will audit and disallow your expenses if they believe you are not truly in business. Contact a Gordon Advisors tax advisor today to discuss.

What’s New for Businesses This Tax Year?

Here’s some new information for business taxpayers in the 2015 tax year:

W-2 Reporting of Employer Health Costs

The Affordable Care Act (ACA) requires certain employers to report the cost of coverage under employer-sponsored group health plans. This reporting is done on W-2 forms. Reporting the cost of health care coverage on Form W-2 doesn’t mean it is taxable. The reporting is for informational purposes only to help employees understand the cost of their coverage.

Currently, this reporting is optional for employers that submit fewer than 250 W-2 forms. But it’s mandatory for employers that submit 250 or more W-2 forms. Compliance requires employers to supply the appropriate reporting codes, which flow to the required W-2 reporting boxes. To further complicate matters, certain types of coverage (such as major medical) currently must be reported, while other types are optional or don’t need to be reported.

W-2 forms must be distributed to employees by February 1, 2016. But gathering the requisite information will be time consuming for most companies. Fortunately, your tax and accounting advisers can assist with W-2 reporting of employer health costs. Be sure to contact them as soon as possible if you need help.

Extenders

Year-end tax planning for 2015 is particularly challenging because Congress has yet to act on a host of tax breaks that expired at the end of 2014. It’s uncertain at this time whether the “extender” provisions will be extended by Congress on a permanent or temporary basis (and whether any such extension would be made retroactive to January 1, 2015). For businesses, these tax breaks include:

1. 50% bonus first-year depreciation for most new machinery, equipment and software,

2. An expanded annual expensing limitation under Section 179 (up to $500,000 for 2014),

3. The research tax credit, and

4. The 15-year write-off for qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property.

Discuss the status of these extenders with your tax adviser before year end.

 

 

 

© Copyright 2015. Thompson Reuters.  All rights reserved. Brought to you by: Gordon Advisors, P.C.

2015 Year-End Tax Planning Tips for Small Businesses

Virtually all small business owners are frustrated with our current tax system. In fact, five out of today’s Top 10 small business concerns relate to state and federal tax issues, according to the Small Business Problems and Priorities survey released by the National Federation of Independent Business (NFIB), a small business advocacy group. Small businesses are most frustrated by the complexity of the tax code and the disparity between effective tax rates of small vs. large businesses. Tax reform will undoubtedly be a hot button during the 2016 presidential race.

Meanwhile, business owners who engage in proactive planning can take some of the “bite” out of their taxes. Here are some simple strategies for you to consider during the fourth quarter of 2015. These maneuvers require action before year end, so don’t delay.

Defer Income and Accelerate Deductible Expenses (or Vice Versa)

The majority of small businesses are organized as so-called “pass-through entities” that don’t pay corporate-level income tax. If your business is a sole proprietorship, partnership, limited liability company or S corporation, your share of the business’s income is reported on your Form 1040 and taxed at your personal rate.

The individual federal income tax rates are scheduled to be the same for 2016 as they are for 2015. Therefore, deferring revenue into 2016 while accelerating deductible expenses into 2015 makes sense if you expect to be in the same or a lower tax bracket next year. In that case, this strategy will, at a minimum, postpone part of your tax bill from 2015 until 2016.

On the other hand, if your pass-through business is thriving, and you expect to be in a higher tax bracket in 2016 (say, 35% vs. 28%), take the opposite approach. If possible, accelerate revenue into 2015 and postpone deductible expenses until 2016. That way, more income will be taxed at this year’s lower effective marginal tax rate instead of next year’s higher rate.

If your business is a C corporation, you need to consider the 2016 corporate income tax rates. They are also scheduled to be the same as in 2015. So if you expect your corporation to be in the same or a lower bracket in 2016, postpone revenue into next year while accelerating deductible expenses into this year. If you expect to be in a higher tax bracket in 2016, try the opposite approach by accelerating taxable income into 2015 and deferring deductible expenses to 2016.

How to Juggle Income and Expenses (for Cash-Basis Entities)

Juggling year-end revenue and expenses is fairly simple if your small business uses the cash method of accounting for tax purposes. The cash method gives you flexibility to manage your 2015 and 2016 taxable income to minimize taxes over a two-year period. Let’s look at some specific cash method strategies to consider if you expect business income to be taxed at the same or lower rate next year.

First, before year end, use credit cards to pay recurring expenses that you would otherwise pay early next year. You can deduct the charges in 2015 even though the credit card bills won’t be paid until next year. This favorable treatment doesn’t apply to revolving charge accounts issued by retailers, however: You can’t generally deduct business expenses charged to your retail store account until you pay the bill.

Another trick is to pay expenses with checks and mail them a few days before year end. The tax rules say cash-basis entities can deduct the expenses in the year checks are mailed, even though they won’t be cashed or deposited until early next year. For big-ticket expenses, send checks via registered or certified mail to prove they were mailed in 2015.

The tax code also allows you to prepay some expenses for next year, as long as the economic benefit from the prepayment doesn’t extend beyond the earlier of:

1. 12 months after the first date on which your business realizes the benefit, or

2. The end of 2016 (the tax year following the year in which the payment is made).

For example, you can claim 2015 deductions for prepaying the first three months of next year’s office rent or prepaying the premium for property insurance coverage for the first half of next year.

On the revenue side, the general rule is that cash-basis taxpayers don’t have to report revenue until the year they receive cash or checks in hand or through the mail. To take advantage of this rule, put off sending out some invoices for work completed in late December so that you won’t get paid until early next year. (Of course, you should never do this if it increases the risk of not collecting the money.)

If you expect to pay a significantly higher tax rate on next year’s business income, try the reverse of these strategies to raise this year’s taxable income and lower next year’s. For example, a cash-basis taxpayer who expects to be in a higher tax bracket in 2016 might ship before year end (and invoice) products scheduled for delivery in early January in the hope that customers will pay by December 31 and hold off on sending checks to vendors until after January 1.

Take Advantage of NOLs

These business tax planning strategies also can be used to create (or increase) a 2015 net operating loss (NOL). This occurs when a business’s expenses exceed its income. You can then choose to carry a 2015 NOL back for up to two years in order to recover taxes paid in earlier years, which may be a welcome boost to your cash flow. Or you can choose to carry the NOL forward for up to 20 years, if you think your business tax rates will go up and the NOL deduction could save you more taxes in the future.

Meet with Your Tax Adviser

These strategies only scratch the surface of proactive tax planning moves. Business owners who assess matters before year end have many more tax-planning strategies at their disposal than those who wait until after the start of the tax filing season.

© Copyright 2015. Thompson Reuters.  All rights reserved. Brought to you by: Gordon Advisors, P.C.

Deducting Tickets to Sporting Events

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by Clarissa M. McCoy, Gordon Advisors, P.C., 248 952 0200

Baseball is in it’s post season, college and pro football season is grinding away and pro basketball and hockey seasons are just starting!  There are a lot of opportunities for companies to take clients, and prospects to many of these games and often companies wonder if they can deduct these sporting event tickets as a business expense, and if so, how to do it correctly.

If you want to deduct as a business expense, the company must meet several conditions.  First, the sporting event must serve a purpose where the parties are there to conduct business.  That means at the sporting event, the parties must engage in a business meeting, negotiation, discussion or transaction.  Also an employee, or representative from the company who provided the tickets must be present.  If they are not, than the tickets are considered a gift.  Additionally, it is recommended that for the business purpose of the sporting event, a private suite is ideal.  Substantial distractions can’t take away from business purposes.

There are many facets when it comes to entertainment, and gift deductions that really depend on the specific situation.  Please call us if you have any questions or specific questions!

Gordon Advisors, P.C. 248 952 0200

What You Need to Know About 529 Plan Withdrawals

The big advantage of Section 529 college savings plans is that withdrawals used to cover qualified higher education expenses are free from federal income tax (and usually state income taxes too). That part is very easy to understand, but the full story on withdrawals is not so simple. What are qualified expenses? What happens if you take out money for expenses that aren’t qualified?

Here are five important facts that you should know about 529 plan withdrawals:

Fact #1: You Have Two Basic Payment Options

  • You can direct the plan to make a withdrawal check out in the name of theaccount beneficiary (meaning the student for whom the account was set up, usually your child or grandchild).
  • You can direct the plan to make a check out in your name as the account owner or plan participant (meaning the person who established and funded the account).

Assuming the withdrawn funds will be used for the benefit of the account beneficiary (to pay for his or her college costs or for whatever other reason), having the check made out to him or her is the recommended option. If the money will be spent on college costs, you can have the beneficiary endorse the check over to you so you can control the spending.

If you as the account owner will keep the withdrawn funds for your own benefit, having the check made out in your name is the recommended option.

Handling withdrawals in this fashion makes it easier to “follow the money” for tax purposes.

Beware: As a matter of state law, you’re not permitted to keep a withdrawal from a 529 account that was funded with money from a custodial account established for the 529 plan beneficiary (your child or grandchild) under a state’s Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA). In this case, the money in the custodial account belongs to the kid, and the money in the 529 account does too because it came from the custodial account. In other words, a 529 account that was funded with custodial account money belongs to the child for whom the custodial account was set up. Therefore, withdrawals must be used for the benefit of the child, and not for your own purposes.

On the other hand, if you funded the 529 account with your own money, you can take withdrawals and do whatever you want with them because it’s your money. Just make sure you understand the tax implications.

Fact #2: The IRS Knows About Withdrawals

When a withdrawal is taken from a 529 account, the plan is supposed to issue a Form 1099-Q, Payments From Qualified Education Programs, by no later than February 1 of the following year.

If withdrawal checks were issued to the account beneficiary, the 1099-Q will come to the beneficiary with his or her Social Security number on it. If checks were issued to you as the account owner, you will receive the form with your Social Security number on it.

Line 1 of the 1099-Q shows the total withdrawn for the year. Assuming the account made money, withdrawals will include some earnings and some tax basis from contributions.

  • Withdrawn earnings are shown on line 2 of the 1099-Q. They may or may not be tax free.
  • Withdrawn basis amounts are shown on line 3. They are always free of any federal income taxes or penalties.

The IRS gets a copy of the Form 1099-Q, so the government knows withdrawals were taken and who received them.

Fact #3: Some Withdrawals May Not Be Tax-Free, Even in Years with Big College Expenses

When the 1099-Q shows withdrawn earnings, the IRS might become interested in looking at the recipient’s Form 1040, because some or all of the earnings might be taxable. Here’s how the tax rules work.

Withdrawn earnings used for the benefit of the account beneficiary are always federal-income-tax-free when total withdrawals for the year do not exceed what the IRS calls the adjusted qualified education expenses, or AQEE, for the year. These expenses equal:

  • The account beneficiary’s tuition and related fees for an undergraduate or graduate program;
  • Room and board (but only if he or she carries at least half of a full-time load); and
  • Books and supplies, computer and Internet access costs.

Once you add up the above costs, then subtract:

  • Costs covered by Pell grants, tax-free scholarships, fellowships, tuition discounts and veterans’ educational assistance;
  • Costs covered by employer-provided educational assistance or any other tax-free educational assistance (not including assistance received by a gift or inheritance);
  • Expenses used to claim the American Opportunity or Lifetime Learning tax credit; and
  • Expenses used to claim the tax deduction for college tuition and fees.

When withdrawals exceed adjusted qualified education expenses, all or part of the withdrawn earnings will be taxable. This little-known fact is an unpleasant surprise for some people.

Example: Ben has $36,000 in college expenses. He receives $24,000 in tax-free scholarships and tuition discounts, so his adjusted qualified education expenses are only $12,000. His parents arrange for a $36,000 withdrawal from Ben’s 529 account. Assume the withdrawal includes $6,000 in earnings. The parents use the money to cover the $12,000 of qualified education expenses, plus Ben’s clothing, pizza, and other incidentals, as well as a car for him to get back and forth to school. Since the $12,000 of adjusted qualified education expenses are only one-third of the 529 withdrawal, only one-third of the withdrawn earnings, or $2,000, is tax free. The remaining $4,000 is taxable and should be reported on the miscellaneous income line of Ben’s Form 1040. Depending on Ben’s overall tax situation and whether the Kiddie Tax applies to him, the tax hit on the $4,000 may or may not be a significant percentage. (The $4,000 of taxable earnings Ben receives counts as unearned income for purposes of the Kiddie Tax rules.)

Tax-wise steps: The parents should direct the plan to issue the withdrawal check in Ben’s name rather than their names. Then, the parents should have Ben endorse the check over to them so they can control the spending. That way, Ben will be issued the 1099-Q and will bear the tax consequences.

Example: This time, assume Ben has $36,000 in adjusted qualified education expenses because he doesn’t receive any scholarships or tuition discounts. Since his qualified expenses do not exceed the amount taken from his 529 account, the withdrawn earnings are federal-income-tax-free. Therefore, the $6,000 is not reported on Ben’s Form 1040.

Fact #4: You Can Usually Keep Withdrawals for Yourself — But there May Be Taxes

Assuming the 529 account was funded with your own money (as opposed to money from your child’s custodial account), you are free to change the account beneficiary to yourself and take federal-income-tax-free withdrawals to cover your own qualified education expenses if you decide to go back to school.

Earnings included in withdrawals that you choose to use for purposes other than education must be included in your gross income and will probably be hit with a 10 percent penalty (explained below).

However, if you liquidate a 529 account that is worth less than you contributed (because of the stock market), there won’t be any withdrawn earnings, so you won’t owe anything to the IRS. You might even be able to claim a tax-saving write-off for your loss.

Fact #5: Withdrawals Not Used for Education Can Be Hit with a Penalty

As explained earlier, the earnings included in 529 account withdrawals that are not used to cover the account beneficiary’s qualified education expenses must be included in gross income. In other words, the earnings are taxable. But there’s more.

According to the general rule, taxable earnings are also hit with a 10 percent penalty tax. However, the penalty tax does not apply to earnings that are only taxable because the account beneficiary’s adjusted qualified education expenses were reduced by Pell grants, tax-free scholarships, fellowships, tuition discounts, veterans’ educational assistance, employer-provided educational assistance or any other tax-free educational assistance (other than assistance received by gift or inheritance), or costs used to claim the American Opportunity or Lifetime Learning tax credit. In addition, the penalty tax doesn’t apply to earnings withdrawn because the beneficiary attends one of the U.S. military academies (such as West Point, Annapolis or the Air Force Academy). Finally, the penalty doesn’t apply to earnings withdrawn if the account beneficiary dies or becomes disabled.

Example: Dave has a falling out with his daughter, who decides not to go to college. Dave liquidates her 529 account, which he funded with his own money, and uses the withdrawal to buy an expensive new car for himself. Assume the 529 withdrawal includes $8,000 of earnings. Dave must report the $8,000 as miscellaneous income on his Form 1040. In addition, he will be socked with the 10 percent penalty tax on the $8,000.

Section 529 plans are one of the most popular ways to save for college. But in addition to knowing the rules for making contributions, it’s important to understand how you can get money out of a 529 plan with the best possible tax outcome. If you have questions, consult with your tax adviser.

 

 

 

© Copyright 2015. Thompson Reuters.  All rights reserved. Brought to you by: Gordon Advisors, P.C.