Santa’s Year End Business Tax Tips

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It’s that time of year again.  Time for Santa Claus to start thinking about his tax return for the new year.  Here are some items to help Santa minimize his tax bill for this coming tax season.

Keeping the Books in 5 Easy Steps: A Super Simple System for Independent Contractors

As an Independent Contractor (IC) you are responsible for paying your own taxes, paying your own expenses, in many cases invoicing, in some cases paying employees and keeping the books.

Most IC’s, unfortunately, don’t keep books or pay taxes as they go – at least the first year.  Generally what happens is they do their taxes at the end of the year and owe a ton of money and that is when they realize that paying taxes and keeping records are a good idea.

Here are some quick tips to get you on the right track so that you don’t owe Big when you file your taxes next year:

1.  Decide whether you are going to track your income and expenses with accounting software or a spreadsheet.  Or, if you are going to use a paper tracking and filing system.

If you are starting out and your business is small you should opt to use either the paper tracking and filing system or some type of spreadsheet software, like Excel or Google’s free online version.  There really isn’t any need to learn accounting software.

2. Purchase some files and a filing cabinet or filing box.  Label the files by Expense Type, not by month like many people do.  Some common expenses for an IC are: Advertising, Insurance, Internet, Legal & Professional, Licenses & Permits, Meals & Entertainment, Postage & Delivery, Printing, Rent, Repairs & Maintenance, Security, Supplies, Small Tools, Taxes, Telephone, Travel/Lodging, Uniforms, Web-site.

These files are where you will store your receipts.

3. Purchase a mileage log to track business mileage.  This can also be done in your calendar.

4. Set up in your spreadsheet a tab for each of the expense types and also a page for Income.  This can also be done with a notebook if you are going the paper route – set up a separate page for each expense type and one for Income.

5. Meet with an accountant to set up payments to the IRS and your State.  If you are savvy with accounting or payroll software you can probably do this yourself, otherwise it is a good idea to get something set up.  You can pay monthly or quarterly, but, the important thing is that you start to pay something in.

Keeping track of your income and expenses only takes a few minutes each week and will make you life much easier during tax season.  If you fail to track your income and expenses during the year and try to track down everything during tax season you could easily miss many tax deductible expenses, not to mention creating unnecessary stress.

If you have any questions about this or any other tax issue, please do not hesitate to e-mail at tim@yeagercpa.com.

Advice For Independent Contractors

An Independent Contractor (IC) is an individual or a business that provides goods or services to another individual or business and is not considered an employee.  Independent Contractors are responsible for paying their own taxes, including Federal, State, Social Security, Medicare and sometimes State and Federal Unemployment.  The business that is being serviced generally does not withhold any taxes from an IC’s pay.

Benefits of IC

The benefits of being considered an IC are:

• The ability to deduct 100% of your business expenses.  As a W-2 employee, your non-reimbursed employee expenses are subject to 2% of your Adjusted Gross Income (AGI), if you itemize deductions on your tax return.  For example, if your AGI is $100,000, then as a W-2 employee you cannot deduct the first $2,000 in business expenses.  As an IC you can deduct 100% of your expenses.
• The ability to set up a separate entity and reduce payroll taxes.  Under most circumstances, as an IC you can set up an LLC or a Corporation and file for S-Corporation status with the IRS.  Doing this allows you to pay yourself a reasonable salary and take any remaining amount as a distribution, saving yourself 15.3% in Self-Employment Tax.

What is Self-Employment Tax?  Self-employment tax is the employer plus the employee portion of Social Security and Medicare.  This is also known as FICA.  When you work as an employee your employer withholds 6.2% for Social Security and 1.45% for Medicare for a total of 7.65%.  The employer then has to match this amount which makes the total FICA 15.3%.  As a self-employed individual you are responsible for both the employer and employee portion.

FICA tax is only applied to payroll, not distributions.  So, why not just set up a separate entity and file for S-Corporation status with the IRS and then take it all as a distribution?  Well, the IRS won’t let you consider it all a distribution.  They require that you pay yourself a reasonable payroll and pay the FICA tax.  However, lets look at how much this can save you in actual dollars if you do set up the separate entity:

Let’s say your profit from your business is $100,000.  You pay yourself a reasonable salary of $40,000 and distributions of $60,000.  The $60,000 would be exempt from FICA and would thus save you $9,180 per year in taxes!

Downside of being an IC

One of the biggest downsides of being an IC is that you are responsible for paying your own taxes, and, you are also responsible for the entire amount of Social Security and Medicare (also known as FICA or Self-Employment Tax) on the portion of your pay that is considered payroll.  When you are an employee your employer pays 1/2 of the total FICA tax.

Many Independent Contractors pay no taxes at all during the year and end up owing the IRS (and sometimes their State) large amounts of back taxes when they file their year-end tax return.  In order to avoid this scenario it is very important to set up monthly or quarterly taxes and to pay as you go.  It is very tempting as an IC to spend everything that comes in without withholding for taxes.  One way to avoid owing back taxes to the IRS and the State is to set up a payroll for yourself by either hiring a payroll service or an accountant or by using accounting software.

Why are so many companies hiring IC’s?

In recent years many companies have started out-sourcing many jobs to Independent Contractors.  The two main reasons for this are to 1) save money on payroll tax and, 2) to transfer liability and risk to the IC.

Although it is sometimes a good business decision to do this, it isn’t always legal.  Simply calling an employee and IC isn’t enough.  The IRS has a list of 20 questions to determine whether or not someone is an employee.  This includes things like:

• Does the employer set the IC’s hours?  If so, they are probably an employee, not an IC.
• Does the IC have any risk in losing money with the job?  If the IC is just making an hourly wage they probably are an employee.  A flat fee type of job involves risk.  For example, if you hire someone to lay tile in your bathroom and agree on a flat fee the contractor is taking a risk that if the job doesn’t go well they could lose money.  If the contractor hires a sub-contractor to do the job, but pays the sub-contractor an hourly wage and tells the sub-contractor what time to be there and how to do the job, the sub-contractor is taking no risk and is probably an employee of the contractor.  On the other hand if the sub-contractor agrees on a flat fee also then he is also an IC and not an employee of the contractor.
• Does the employer provide training?  If so, the IC is probably an employee.

It is important to note that you have to look at all 20 questions and look at each situation separately to determine whether someone is an IC or an employee.

What are some of the common deductions that an IC can take?

Common deductions for an IC are:

• Home Office
• Mileage
• Advertising and Marketing
• Depreciation for autos and office equipment/furniture
• Health Insurance
• Legal and Professional Fees
• Office Rent
• Office Supplies
• Other Supplies
• Repairs and Maintenance
• Travel
• Meals & Entertainment
• Utilities
• Telephone
• Internet Service
• Credit Card Processing

If you have any questions about this or any other tax issue, please do not hesitate to contact my office at (757) 434-3089.

Tax Update for 2014

Here are a few tax changes in 2014 to be aware of. The biggest change is related to the “Affordable” Care Act.

1. If you don’t have health insurance in 2014 you will be hit with a whopping $95 per person penalty or 1% of your AGI, whichever is more. The penalty for children under 18 is $47.50. Not exactly enough to encourage anyone to run out and purchase health insurance, but, it does increase in 2015 and 2016.

2. Companies of 50 employees or more are still exempt from the law for 2014 as the administration picks and chooses which laws to enforce. Once we get through the mid-term elections, the 50 or more requirement will kick in (2015). Of course, the negative effects of this law have been felt on the economy for some time now, as companies near the 50 employee cutoff have either stopped hiring, converted workers to part-time or outsourced work to sub-contractors.

3. If you don’t have health insurance in 2014 and get hit with the penalty, the IRS cannot fine you for it, they can only withhold it from any potential tax refund. That doesn’t really make any sense from a tax preparation prospective. It will be interesting to see what the tax forms will look like since there will need to be a separate line item for Health Insurance Penalty, not collectible, but only deducted from refunds.

4. The following tax breaks for businesses have expired: The work opportunity tax credit. The research and development tax credit. Leasehold improvements are now 39-year depreciation again instead of 15. Bonus depreciation is gone. Section 179 is now limited to $25,000. These tax breaks could be retroactively put back in place effective Jan. 1 if Congress acts but we will see.

5. The amount you can give someone per year without filing gift tax return remains at $14,000.

6. Capital gains tax is 23.8% for high tax bracket filers.

Tax Season Opens January 31st

The IRS has announced that the first date to file your 2013 Individual tax return will be January 31st, 2014.  The delay is being blamed on the partial government shutdown in October 2013.  The due date for Individual returns is still April 15th.

The January 31st opening date doesn’t mean you have to wait until then to do your taxes.  Most firms, including ours, will do your taxes now and then submit the e-file on January 31st.

Business returns can be filed as early as January 13th.  Of course, most businesses haven’t even mailed out their W-2’s by January 13th, much less have their books in order to begin the process of preparing their tax return.

Tax Season Opens Tomorrow

The Big Day has finally arrived.  Tax season opens tomorrow, 01/30/2013.  Taxpayers can now e-file their returns and expect their refunds…sometime in the near future.  Unfortunately the IRS hasn’t published a Refund Cycle Chart this year.  It will be interesting to see how long direct deposit refunds take this year.

Businesses will have to wait much longer to file.  Many business forms won’t be available until late February or early March, including Form 4562 Depreciation, which almost every business uses.

This is all thanks to the so called “fiscal cliff” and last minute legislation.

The Fiscal Cliff Prediction

(fear) the Fiscal Cliff… (Photo credit: MyEyeSees)

The Republican House and the President will come to an agreement at the 11^th hour.  They will both give a little.  The President wants to increase taxes on those making $250,000 or more a year.  The Republicans want to extend the “Bush Tax Cuts” for everyone.  I believe that something like this will happen:

Scenario 1: They will extend the Bush Tax Cuts for everyone except those making $350,000-$500,000 or more per year.

Scenario 2: They will extend all the Bush Tax Cuts but significantly reduce deductions (i.e. mortgage interest) for everyone making $250,000 or more per year.

Scenario 3: They will extend the Bush Tax Cuts for everyone except those making $250,000 or more per year but will make significant cuts to various welfare programs.

Or, we might see a combination of the above three scenarios.

No matter how they agree, the stock market could soar because of the “fiscal cliff” being averted.

“Conservative” Group Pushes for Sales Tax on Services

The Thomas Jefferson Institute for Public Policy, a supposedly center-right public policy foundation, is pushing for sales taxes to be collected on most services in Virginia.  The law would include services provided to the public but not business-to-business services.  This would include tax preparation, legal services, transportation, shipping services, insurance, private education, auto repair, hair services, dry cleaning, landscaping services, apartments, bowling, and the list goes on and on.  The new law would be “revenue-neutral” (what they always say) and would eliminate the Business and Professional Occupational Tax (Business License), Business Personal Property Tax and Business Inventory Tax.

Although I like the idea of getting rid of Business License fees and Property and Inventory Taxes, I don’t like the idea of charging sales taxes on services.  Charging a sales tax on services is the same as charging sales taxes on labor.  As we all well know, labor is already taxed extensively through the Federal Income Tax, State Income Tax, Social Security Tax, Medicare Tax, State Unemployment Tax and Federal Unemployment Tax.  Now, they want us to collect and remit sales tax to the state for services?

This also creates burdensome accounting.   For example, if you pay someone to mow your lawn as an independent contractor then under this new law they would also be required to collect sales tax from you and remit it to the State.  That seems to me like a paperwork nightmare, especially for small operators.  And, it increases the potential for fraud.  How much of this new tax will never get remitted to the State?

Although this tax is paid by the public, it will eat into the pockets of service providers.  There are certain price points that people will pay, tax included.  Thus, service providers will have to lower their prices to accommodate the new tax.  Also, it will give an unfair advantage to those small operators who skirt the law and don’t collect or report the tax at all.  I say, “Two Thumbs Down” on this idea!

April 15th (April 17th): Just Another Day

Please, don’t stress about April 17th, the due date for this year’s Individual and Partnership Federal Income Tax Returns.  April 17th is NOT a hard deadline.  Just file an extension and if you think you might owe money make an estimated payment to avoid interest and penalties on the amount due.  Keep in mind, the point of filing an extension, if you owe money, is to avoid a late FILING penalty.

So, why all the hoopla surrounding the tax “deadline”?  We are programmed from an early age to fear the IRS.  Many people believe that if they don’t file their tax return by April 15th (April 17th) they might face serious fines or even go to jail.  Of course, that isn’t really true unless you owe a lot of money and don’t file at all.

Here are the facts:

1.  If you are due a refund, there are no penalties if you file late.  Yep, that’s correct (for Federal returns).  The IRS will even pay you interest on the amount they owe you!  (at .000000001% or something like that)

2. If you owe money, you can avoid late filing penalties by filing an extension.   For Individuals the extension is 6-months and for Partnerships it is 5-months.

So, relax, stop stressing and file an extension.

Business License Fees Punish Success

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Like most other responsible business owners in Chesapeake, VA I renewed my business license before March 1st of this year.  One of the things that has always seemed odd to me is how the license fee is calculated.  If you make less than $100,000, your business license is $50.  But, if you make $100,000 or more, you pay a percentage of gross revenue.  For accountants it is 58 cents per $100, or 0.58%.  In other words, if you have $99,999.99 in revenue your business license is $50, but if your revenue is $100,000.00 your business license is $580.

Of course, a third grader could see why this isn’t fair.  That one extra penny costs you $530 in extra license fees.

Whoever set this up was either too incompetent to implement a gradual system or simply didn’t care.

From a political standpoint, I can see why this would be hard to change.  It would be practically impossible to keep business license fees revenue neutral without raising taxes on someone.  For example, if you lowered the $50 cutoff to $75,000 and then said that business license fees are $50 for the first $75,000 and a percentage of revenue for everything above that then you would be raising fees on businesses that bring in between $75,000 – $100,000 but lowering fees on those that bring in above $100,000.  On the flip side if you had a partially graduated scale where the first $99,999.99 was still $50 but $100,000 – $125,000 was $50 plus a percentage of the amount over $100,000 and then increased taxes on the amounts above $125,000 to make up for the loss of license fees on the amounts lower than $100,000 then you would be increasing fees on those businesses with more than $125,000 in revenue.  Business license fees are already high enough and shouldn’t be raised on anyone.

The only fair solution is to charge $50 for the first $100,000 and then a percentage on everything above that.  Of course, doing this will lower tax revenue to the city (which is not necessarily a bad thing).  And, “fair” is a relative term.  It would be “fair” to make everyone pay a percentage of sales, regardless of how much those sales are.  If you bring in

$90,000, for example, instead of $50, you would pay a percentage.  But, of course, making it “fair” would cause an increase in license fees for those businesses with revenues of less than $100,000, and I would never be for increasing taxes or fees on small businesses.

Another solution is to implement a graduated scale from $100,000 – $125,000 (for example) and not raise rates on those above $125,000.  This would fix the “one penny costing $530 problem”.  This would also cause a loss of revenue to the city.

Thus, the only way to fix this improper business license calculation without raising taxes on anyone is for the city to take a cut in tax revenue.  But, worse things have happened.  If doing the right thing means less revenue to the city then so be it.