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.

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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.

Tax Relief for Victims of Severe Storms and Flooding in Michigan – IRS Update

Detroit — Victims of the severe storms and flooding that began on Aug.11, 2014 in parts of Michigan may qualify for tax relief from the Internal Revenue Service.

Following recent disaster declarations for individual assistance issued by the Federal Emergency Management Agency (FEMA), the IRS announced today that affected taxpayers in Michigan will receive tax relief, and other locations may be added in coming days based on additional damage assessments by FEMA.

The President has declared Macomb, Oakland and Wayne counties a federal disaster area. Individuals who reside or have a business in these counties may qualify for tax relief.

The declaration permits the IRS to postpone certain deadlines for taxpayers who reside or have a business in the disaster area. For instance, certain deadlines falling on or after Aug. 11, 2014 and on or before Jan. 15, 2015, have been postponed through Jan. 15, 2015. This includes corporations and businesses that previously obtained an extension until Sept. 15, 2014, to file their 2013 returns and individuals and businesses that received a similar extension until Oct. 15. It also includes the estimated tax payment for the third quarter of 2014, which would normally be due Sept. 15.

If an affected taxpayer receives a penalty notice from the IRS, the taxpayer should call the telephone number on the notice to have the IRS abate any interest and any late filing or late payment penalties that would otherwise apply. Penalties or interest will be abated only for taxpayers who have an original or extended filing, payment or deposit due date, including an extended filing or payment due date, that falls within the postponement period.

The IRS automatically identifies taxpayers located in the covered disaster area and applies automatic filing and payment relief. But affected taxpayers who reside or have a business located outside the covered disaster area must call the IRS disaster hotline at 866-562-5227 to request this tax relief.

Covered Disaster Area

The counties listed above constitute a covered disaster area for purposes of Treas. Reg. § 301.7508A-1(d)(2) and are entitled to the relief detailed below.

Affected Taxpayers

Taxpayers considered to be affected taxpayers eligible for the postponement of time to file returns, pay taxes and perform other time-sensitive acts are those taxpayers listed in Treas. Reg. § 301.7508A-1(d)(1), and include individuals who live, and businesses whose principal place of business is located, in the covered disaster area. Taxpayers not in the covered disaster area, but whose records necessary to meet a deadline listed in Treas. Reg. § 301.7508A-1(c) are in the covered disaster area, are also entitled to relief. In addition, all relief workers affiliated with a recognized government or philanthropic organization assisting in the relief activities in the covered disaster area and any individual visiting the covered disaster area who was killed or injured as a result of the disaster are entitled to relief.

Grant of Relief

Under section 7508A, the IRS gives affected taxpayers until Jan. 15, 2015 to file most tax returns (including individual, corporate, and estate and trust income tax returns; partnership returns, S corporation returns, and trust returns; estate, gift, and generation-skipping transfer tax returns; and employment and certain excise tax returns), or to make tax payments, including estimated tax payments, that have either an original or extended due date occurring on or after Aug. 11, 2014 and on or before Jan. 15, 2015.

The IRS also gives affected taxpayers until Jan. 15, 2015 to perform other time-sensitive actions described in Treas. Reg. § 301.7508A-1(c)(1) and Rev. Proc. 2007-56, 2007-34 I.R.B. 388 (Aug. 20, 2007), that are due to be performed on or after Aug. 11, 2014 and on or before Jan. 15, 2015.

This relief also includes the filing of Form 5500 series returns, in the manner described in section 8 of Rev. Proc. 2007-56. The relief described in section 17 of Rev. Proc. 2007-56, pertaining to like-kind exchanges of property, also applies to certain taxpayers who are not otherwise affected taxpayers and may include acts required to be performed before or after the period above.

The postponement of time to file and pay does not apply to information returns in the W-2, 1098, 1099 series, or to Forms 1042-S or 8027. Penalties for failure to timely file information returns can be waived under existing procedures for reasonable cause. Likewise, the postponement does not apply to employment and excise tax deposits. The IRS, however, will abate penalties for failure to make timely employment and excise tax deposits due on or after August 11 and on or before August 26 provided the taxpayer makes these deposits by Aug. 26, 2014.

Casualty Losses

Affected taxpayers in a federally declared disaster area have the option of claiming disaster-related casualty losses on their federal income tax return for either this year or last year. Claiming the loss on an original or amended return for last year will get the taxpayer an earlier refund, but waiting to claim the loss on this year’s return could result in a greater tax saving, depending on other income factors.

Individuals may deduct personal property losses that are not covered by insurance or other reimbursements. For details, see Form 4684 and its instructions.

Affected taxpayers claiming the disaster loss on last year’s return should put the Disaster Designation “Michigan/Severe Storms and Flooding” at the top of the form so that the IRS can expedite the processing of the refund.

Other Relief

The IRS will waive the usual fees and expedite requests for copies of previously filed tax returns for affected taxpayers. Taxpayers should put the assigned Disaster Designation in red ink at the top ofForm 4506, Request for Copy of Tax Return, or Form 4506-T, Request for Transcript of Tax Return, as appropriate, and submit it to the IRS.

Affected taxpayers who are contacted by the IRS on a collection or examination matter should explain how the disaster impacts them so that the IRS can provide appropriate consideration to their case.

Taxpayers may download forms and publications from the official IRS website, irs.gov, or order them by calling
800-TAX-FORM (800-829-3676). The IRS toll-free number for general tax questions is 800-829-1040.

IRS Repeats Warning about Phone Scams

WASHINGTON — The Internal Revenue Service and the Treasury Inspector General for Tax Administration continue to hear from taxpayers who have received unsolicited calls from individuals demanding payment while fraudulently claiming to be from the IRS.

Based on the 90,000 complaints that TIGTA has received through its telephone hotline, to date, TIGTA has identified approximately 1,100 victims who have lost an estimated $5 million from these scams.

“There are clear warning signs about these scams, which continue at high levels throughout the nation,” said IRS Commissioner John Koskinen. “Taxpayers should remember their first contact with the IRS will not be a call from out of the blue, but through official correspondence sent through the mail. A big red flag for these scams are angry, threatening calls from people who say they are from the IRS and urging immediate payment. This is not how we operate. People should hang up immediately and contact TIGTA or the IRS.”

Additionally, it is important for taxpayers to know that the IRS:

  • Never asks for credit card, debit card or prepaid card information over the telephone.
  • Never insists that taxpayers use a specific payment method to pay tax obligations
  • Never requests immediate payment over the telephone and will not take enforcement action immediately following a phone conversation. Taxpayers usually receive prior notification of IRS enforcement action involving IRS tax liens or levies.

Potential phone scam victims may be told that they owe money that must be paid immediately to the IRS or they are entitled to big refunds. When unsuccessful the first time, sometimes phone scammers call back trying a new strategy.

Other characteristics of these scams include:

  • Scammers use fake names and IRS badge numbers. They generally use common names and surnames to identify themselves.
  • Scammers may be able to recite the last four digits of a victim’s Social Security number.
  • Scammers spoof the IRS toll-free number on caller ID to make it appear that it’s the IRS calling.
  • Scammers sometimes send bogus IRS emails to some victims to support their bogus calls.
  • Victims hear background noise of other calls being conducted to mimic a call site.
  • After threatening victims with jail time or driver’s license revocation, scammers hang up and others soon call back pretending to be from the local police or DMV, and the caller ID supports their claim.

If you get a phone call from someone claiming to be from the IRS, here’s what you should do:

  • If you know you owe taxes or you think you might owe taxes, call the IRS at 1.800.829.1040. The IRS employees at that line can help you with a payment issue, if there really is such an issue.
  • If you know you don’t owe taxes or have no reason to think that you owe any taxes (for example, you’ve never received a bill or the caller made some bogus threats as described above), then call and report the incident to TIGTA at 1.800.366.4484.
  • If you’ve been targeted by this scam, you should also contact the Federal Trade Commission and use their “FTC Complaint Assistant” at FTC.gov. Please add “IRS Telephone Scam” to the comments of your complaint.

Taxpayers should be aware that there are other unrelated scams (such as a lottery sweepstakes) and solicitations (such as debt relief) that fraudulently claim to be from the IRS.

The IRS encourages taxpayers to be vigilant against phone and email scams that use the IRS as a lure. The IRS does not initiate contact with taxpayers by email to request personal or financial information. This includes any type of electronic communication, such as text messages and social media channels. The IRS also does not ask for PINs, passwords or similar confidential access information for credit card, bank or other financial accounts. Recipients should not open any attachments or click on any links contained in the message. Instead, forward the email to phishing@irs.gov.

For more information or to report a scam, go to http://www.irs.gov and type “scam” in the search box.

More information on how to report phishing scams involving the IRS is available on the genuine IRS website, IRS.gov.

Manufacturing Companies: Planning an Equipment Purchase?

One of the best tax breaks available to manufacturers is the Section 179 deduction, which allows you take a current deduction on equipment and business vehicles, rather than depreciating it over many years.

The maximum amount for 2013 is $500,000 (*see below for 2014). In order to qualify for the tax break, you must use the equipment more than 50 percent of the time for business.

Tip: Many business owners are involved in more than one venture. In the case of pass-through entities (partnerships, LLCs, and S corporations), the dollar limitation rules for the Section 179 deduction apply at both the entity level and the owner level. (IRS Regulation 1.179-2)

Therefore, advance planning may be necessary to maximize Section 179 deductions at the owner level, which is where the write-offs really count. Your tax adviser can provide all the details.

*Unless Congress acts to renew this at a higher level, this important provision has dropped in 2014 to only $25,000 spending allowance (down from $500,000 in 2013) with an overall threshold of only $200,000 (down from $2,000,000 in 2013).

There are restrictions. Contact us to ensure that you get the maximum equipment deduction allowed in your company’s situation.
© Copyright 2014. Thompson Reuters.  All rights reserved. Brought to you by: Gordon Advisors, P.C.