Archive for Self Employ
February 7, 2012 John R. Dundon II Accounting Method, Business Expense, Business Income, Car expense, Depreciation, Disallowed Expenses, Employee Business Expense, Entity Classification, FICA, Health Insurance, Hobby, Home Office, Husband/Wife, Medicare, Net Operating Loss, NOL, Passive Activity, Self Employ, Small Business, Social Security, Social Security Tax, Sole Proprietor, Start up costs, Sub-chapter S, Tax Guidance & Preparation, Tax Problems & Requests The sole proprietorship or Limited Liability Corporation (LLC) is in my opinion the easiest type of business entity to set up and begin operating. It is not separate from its owner with the income and expenses reported on IRS Form 1040 Schedule C.
Some people have instant success with a venture that is profitable from the very beginning. However it is more common to be unprofitable in the first 24 to 36 months of operation. If you are loosing money it is important to remember that you MUST REPORT A PROFIT IN 2 OUT OF THE PREVIOUS 5 TAX YEARS TO AVOID BEING CONSIDERED BY THE IRS TO BE REALLY ENGAGED IN A HOBBY. For more details on the specifics of hobby versus business see my post at: http://johnrdundon.com/how-to-determine-what-is-a-business-vs-what-is-a-hobby/
When it comes to losses the other thing to keep in mind is that they can be limited basically in three different ways:
1. By the amount of your investment or basis limitation;
2. By the amount you have at risk or at-risk limitation; and
3. By the passive activity loss limitation.
Basis limitations do not apply to sole proprietors as they would with an S corporation shareholder or partner in a partnership. A sole proprietorship is predominantly financed by the proprietors own assets. Two obstacles must be overcome before a Schedule C loss is deductible as addressed in this particular order:
1. The at-risk limitations of IRC Sec. 465; and
2. The passive activity loss limitations of IRC Sec. 469.
The at-risk limitations apply before any loss is limited due to lack of material participation which is a threshold criteria of a passive activity. The proprietor’s at-risk limitation is calculated on IRS Form 6198. If a taxpayer cannot verify a material-participation level with respect to the Schedule C activity, then being at-risk for the loss is essentially immaterial. The at-risk concept is one that looks at the source of funds for the business. Usually sole proprietors would not be at-risk when:
• The business was financed with non-recourse loans – except for holding real property;
• A valid guarantee or stop-loss agreement is in force; or
• Amounts borrowed for use in the business are from a person with an interest in the business, other than a creditor, or who is
related to a person having an interest in the business under IRC Sec. 465(b)(3)(C).
Most all small businesses with gross receipts of $1 million or less are allowed to use the cash method of accounting (Rev. Proc. 2001-10). New proprietors generally begin using the cash method of accounting immediately. An existing business may qualify to change its accounting method by filing IRS Form 3115 – Application for Change in Accounting Method with its tax return under the automatic consent procedures. When changing from an accrual to a cash method of accounting usually a negative IRC Sec. 481(a) adjustment is deducted in the year of the change and a positive IRC Sec. 481(a) adjustment is generally reported in income over a four-year period.
Office-in-home deduction items are detailed separately on IRS Form 8829 Expenses for Business Use of Your Home rather than on the expense lines for rent, utilities, interest, etc.
Proper deduction of vehicle expenses includes a decision for utilizing the cents-per-mile deduction or the actual method. Both methods require maintaining a mileage log and an understanding
of which miles are business miles.
Additionally, an understanding of depreciation methods available, which includes knowing the weight of the vehicle, are important. IRC Sec. 179 deductions are limited to income, but regular depreciation, including bonus depreciation, can actually assist in creating or increasing an net operating loss (NOL).
From my perspective an overall tax rate somewhere between 25 and 30 percent for all federal and state taxes combined is the point where my clients generally are enticed to invest more money in their business and create jobs. When their real total tax rate gets any higher than this they tend to just hold on to profits and take care of their own, batten down the hatches, trench in, maintain the status. Stop taking risks.
When a flat economy persists like the one we face now people tend to crave ANY SIGN of long-term certainty to have the courage to borrow money for growth. However when these people see that their hard work and risk taking will be eaten up in taxes their motivation wanes. Some people chose to hang on to existing operations and survive. Most people fall into the trap of spending their profits and leaving no cash for taxes. Indeed when you plan no cash for taxes the death spiral begins.
For those in the private sector fortunate enough to thrive these are the three ideas I espouse to create jobs:
• Allow privately held C corporations a tax deduction for dividends paid so as to encourage payment of excess capital back into the marketplace.
• Withhold taxes on ALL flow of funds to encourage owners to not fall into bad habits of taking money out of the business without considering tax implications until it is too late.
• Eliminate itemized deductions. Instead adjust personal exemptions and a standard deduction to some reasonable level to protect the lower income levels, but after that, make it simple and non-tax motivated.
Check out IRS Form 8941, Credit for Small Employer Health Insurance Premiums (PDF) if you are interested in the small business health care tax credit.
Many small employers that pay at least half of the premiums for employee health insurance coverage under a qualifying arrangement may be eligible for the small business health care tax credit. This credit can enable small businesses and small tax-exempt organizations to offer health insurance coverage for the first time. It also helps those already offering health insurance coverage to maintain the coverage they already have. The credit is specifically targeted to help small businesses and tax-exempt organizations that primarily employ 25 or fewer workers with average income of $50,000 or less.
Businesses who have already filed can still claim the credit. For small businesses that have already filed and later determine they are eligible for the credit, they can always file an amended 2010 tax return. Corporations use Form 1120X and individual sole proprietors use Form 1040X.
Businesses that could not use the credit in 2010 may be eligible to claim it in future years. Some businesses that already locked into health insurance plan structures and contributions for 2010 may not have had the opportunity to make any needed adjustments to qualify for the credit for 2010. So these businesses may be eligible to claim the credit on 2011 returns or in years beyond. Small employers can claim the credit for 2010 through 2013 and for two additional years beginning in 2014.
For tax years 2010 to 2013, the maximum credit for eligible small business employers is 35 percent of premiums paid and for eligible tax-exempt employers the maximum credit is 25 percent of premiums paid. Beginning in 2014, the maximum tax credit will go up to 50 percent of premiums paid by eligible small business employers and 35 percent of premiums paid by eligible tax-exempt organizations. Also check out…
The benefits available to a self-employed individual in a solo 401(k) plan have increased. The self-employed individual can contribute to the solo 401(k) plan two ways:
Through elective deferrals limited to the lesser of $16,500 or 100% of the self-employed individual’s compensation for 2011 and 2012.
Through employer contributions limited to 20% of the self-employed individual’s compensation. The total of all contributions cannot exceed the lesser of 100% of the self-employed individual’s compensation or $49,000 for 2011. An additional amount of $5,500, for 2011, can be contributed if the self-employed individual has attained at least age 50 by the calendar year-end.
The self-employed individual’s compensation is defined as self-employment income after the deduction for half of the self-employment tax and the self-employed individual’s deductible contribution to the plan. Since the self-employed individual’s compensation is calculated in this manner it creates a simultaneous reduction in the maximum percentage amount the owner is able to contribute. To avoid this complicated calculation, the self-employed individual’s maximum contribution percentage can be figured by dividing the percentage amount allowed by the plan for the owner and employee by one plus the owner-employee’s contribution percentage (owner-employee % / (1 + owner-employee %)). For instance, if the self-employed individual’s plan document has a stated contribution percentage of 18% the self-employed individual’s actual maximum contribution percentage is 15.25% (18% / (1 + 18%)).
As a general rule, if the plan document states an owner-employee contribution percentage of 25%, the self-employed individual’s maximum contribution percentage is 20%. Therefore, after finding the self-employed individual’s maximum contribution percentage, using the above formula, the self-employed individual’s compensation amount is self-employment income after the deduction of half the self-employment tax.
As a side note, the self-employed individual’s deductible contribution amount is equal to the amount determined by multiplying the self-employed individual’s maximum contribution percentage by self-employed individual’s compensation (self-employment income after the deduction for half of the self-employment tax). This is the amount deducted on Form 1040 line 29, not a Schedule C deduction
The small employer health insurance credit is applied for on IRS Form 8941. The credit itself is based on the non-shareholder staff, their hours worked, wages and the premiums paid for them. The hours worked, wages and health insurance premiums of shareholders are not taken into account for purposes of the credit under §45R(e)(1)(A).
I blog today about 401(K)’s from a tax perspective solely keeping in mind that my license is as an Enrolled Agent with the US Treasury. With that as a basis the benefits available to a self-employed individual in a solo 401(k) plan have increased. The self-employed individual can contribute to the solo 401(k) plan two ways:
Through elective deferrals limited to the lesser of $16,500 or 100% of the self-employed individual’s compensation for 2011 and 2012.
Through employer contributions limited to 20% of the self-employed individual’s compensation. The total of all contributions cannot exceed the lesser of 100% of the self-employed individual’s compensation or $49,000 for 2011. An additional amount of $5,500, for 2011, can be contributed if the self-employed individual has attained at least age 50 by the calendar year-end.
The self-employed individual’s compensation is defined as self-employment income after the deduction for half of the self-employment tax and the self-employed individual’s deductible contribution to the plan. Since the self-employed individual’s compensation is calculated in this manner it creates a simultaneous reduction in the maximum percentage amount the owner is able to contribute. To avoid this complicated calculation, the self-employed individual’s maximum contribution percentage can be figured by dividing the percentage amount allowed by the plan for the owner and employee by one plus the owner-employee’s contribution percentage (owner-employee % / (1 + owner-employee %)). For instance, if the self-employed individual’s plan document has a stated contribution percentage of 18% the self-employed individual’s actual maximum contribution percentage is 15.25% (18% / (1 + 18%)).
As a general rule, if the plan document states an owner-employee contribution percentage of 25%, the self-employed individual’s maximum contribution percentage is 20%. Therefore, after finding the self-employed individual’s maximum contribution percentage, using the above formula, the self-employed individual’s compensation amount is self-employment income after the deduction of half the self-employment tax.
As a side note, the self-employed individual’s deductible contribution amount is equal to the amount determined by multiplying the self-employed individual’s maximum contribution percentage by self-employed individual’s compensation (self-employment income after the deduction for half of the self-employment tax). This is the amount deducted on page 1 of Form 1040 as an adjustment to income, not as a Schedule C deduction.
It has been truly amazing to see so many failed payroll service providers all around the United States screw over small business owners by collecting tax revenue from business owners to be passed on to federal and state governments and then fail to turn the money over to the governments before closing up shop and leaving the small business owner liable for payroll taxes to the government already paid once to the payroll service provider.
Usually several weeks or even months pass by without the small business owner recognizing the magnitude of such an event. This is a federal offense bringing with it HUGE PENALTIES and even incarceration. These nefarious payroll organizations bring a bad name to legitimate payroll service providers meaning that background checks should be carefully conducted on any entity engaged.
Many small business owners usually don’t realize that as an Officer of their entity (usually the sole Officer) they (up until recently) were the only people personally “responsible” for the fraudulent failure to submit payroll taxes of their contractually engaged payroll services providers.
The memorandum expands the scope of “responsible persons” under Code §6672 to include third-party payers, such as payroll service providers (PSPs) and professional employer organizations (PEOs) and complies with the recommendations made by the IRS National Taxpayer Advocate. This memorandum is an attempt to protect businesses from PSPs and PEOs that have to pay the IRS withheld payroll taxes.
Taxpayers who own shares in an S corporation are allowed pass-through losses to the extent of their basis (also commonly referred to as investment) under §1366(d) in their entity. Shareholders can obtain basis in a variety of ways such as direct investment, loaning the corporation money, contributing capital etc. However sharholders of S Corporations do not gain basis by personally guaranteeing debts of the corporation.
In Spencer v. Commissioner, 110 TC 62, TC Memo 2010-55, the Court ruled that mere shareholder guaranties of S corporation indebtedness generally fail to satisfy the requirements of §1366(d)(1)(B) because there is no economic outlay or direct indebtedness between the corporation and its shareholders. In other words no form of indirect borrowing, including personal guaranties, gives rise to indebtedness from the corporation to the shareholder unless the shareholder pays part or all of the obligation. As such there is no increase in basis by personally guaranteeing a debt for the Sub-chapter S Corporation that you own, if you own one.
July 29, 2011 John R. Dundon II Abusive Tax Shelter, Entity Classification, Self Employ, Small Business, Sole Proprietor, Sub-chapter S, Tax Abuse, Tax Court, Tax Fraud, Tax Guidance & Preparation To be taxed as an S corporation, a C corporation must elect S status by filing IRS Form 2553. Electing S status is fairly simple for a new or existing corporation, but meeting the requirements for S status can be more complex when the C corporation is not owned by an individual. Eligibility is based on §1361, which states only a “small business corporation” can obtain S status to be taxed as an S corporation. Under Reg. §1.1361-1(e) (1) the person for whom stock is held by a nominee, guardian, custodian or an agent is considered to be the shareholder of the corporation.
In Taproot Administrative Services, Inc. v. Commissioner the IRS disallowed the S election on the basis that an IRA is not an eligible shareholder. They based their opinion on Rev. Rul. 92-73, which disallowed an IRA as a shareholder, stating the code does not specifically address an IRA as a shareholder in an S corporation. Rev. Rul. 92-73 was based on the fact that a beneficiary of an IRA or Roth IRA is not taxed on current income for the year, but taxed when the money is distributed. Trusts allowed to own stocks in an S corporation are taxed currently either at the trust level or the beneficiary level, and are therefore eligible shareholders of an S corporation.
Taxation of IRAs are governed under §408 and §408A, which allow the owners or beneficiaries of an IRA to defer any tax or gain until the amounts are distributed. IRAs are taxed on unrelated business income under §511 where income from an S corporation would be unrelated income for the exempt account.
The Court upheld the IRS’ position regarding Rev. Rul. 92-73, stating IRAs cannot be the owners of S corporation stock because the beneficiaries are not currently taxed on the S corporation’s income, and Congress did not include IRAs in §1361 as eligible S corporation shareholders.
Many medical costs are deductible including the cost of treatment to alleviate conditions or diseases and the cost of prescriptions and certain diagnostic services. Additional deductible medical expenses include:
Capital expenses for special equipment installed in, or improvements made to, a home that provides a medical benefit; these include wider doorways, entrance ramps, modified bathroom or kitchen equipment, and swimming pools for therapeutic purposes.
Cosmetic surgery, if necessary to improve a deformity related to a congenital abnormality, accident, or disease.
Dental treatments, including braces and dentures.
Meals and lodging, if the stay is at a hospital or similar institution to obtain medical care.
Orthopedic shoes (extra cost over regular shoes).
Prosthetic limbs.
Oxygen and equipment used to relieve medical breathing problems.
Smoking cessation programs and prescribed drugs to alleviate nicotine withdrawal.
Visual alert systems for the hearing-impaired.
Medical aids such as wheelchairs, hearing aids, crutches, needles, and other diagnostic devices such as blood sugar kits.
Guide dogs or other animals used by taxpayers who are visually or hearing impaired or are otherwise disabled.
Weight loss programs as treatment for a specific disease; obesity is a disease as long as diagnosed by a physician. The Tax Court has allowed the extra cost for special diets over the cost of a normal diet when prescribed by a physician to alleviate a specific medical condition.
Alcohol and drug addiction treatment, meals, and lodging at a therapeutic center for addictions.
Tuition for day-camp programs designed for children with disabilities.
The cost of hand controls for a vehicle for the physically handicapped, or the extra cost to design a vehicle to hold a wheelchair.
Detachable items such as air conditioners, heaters, humidifiers, and air cleaners used for the benefit of a sick person or for the relief of allergies or other respiratory ailments.
Laser eye surgery that meaningfully promotes the proper function of the eyes; vision correction with eyeglasses or contact lenses is also allowed.
Out-of-pocket transportation expenses for medical reasons
Medical expenses that are not deductible include the following:
Maternity clothes.
Teeth-whitening.
Diaper services (unless needed to relieve the effects of a particular disease).
Dancing lessons, even if recommended by a physician.
Funeral expenses.
Exercise programs to improve general health, even if recommended by a physician.
Marijuana, even if legal under state law when prescribed by a physician in the state where the taxpayer lives.
Health club dues (unless they are related to a specific medical condition).
Vitamins and other nutritional supplements (unless prescribed by a physician as treatment for a specific, diagnosed medical condition.
You may only deduct the amount of expenses in excess of 7.5% of adjusted gross income. If deductions on Schedule A (including medical expenses) are not more than the standard deduction, they may not prove helpful on the federal return, though in many states they may become advantageous.
Medical expenses are reduced by payments from insurance or other sources. Payments received for the permanent loss or use of a member or function of the body, for loss of earnings related to a physical injury, or damages due to personal injury or sickness do not reduce expenses.
The one thing that many people over look is that excess reimbursements for medical expenses may need to be included in income. If you are reimbursed the amount up to the deduction must be included in income if it was previously deducted.
Taxpayers may also be able to claim expenses for themselves as well as other qualifying persons. A good example of this might be expenses for a parent for whom over half the support is provided.
