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Posts Tagged ‘tax’

Have you been thinking about incorporating your small business or self-employment activity? The advantages are many!

For starters, you’ll be protecting yourself and your family from the possibility of a business ending lawsuit. Forming a corporation is Step One on the path known as “Asset Protection” — you are moving from the world of unlimited liability to the world of limited liability.

(NOTE: For further insight into the legal advantages of incorporating, check out the article: “It Can Happen To You: Why Any Sole Proprietorship Is A Risky Business” at http://www.YouSaveOnTaxes.com/happen-to-you.html)

From a tax standpoint, there are both advantages and disadvantages to incorporating. Yes, forming a corporation can either reduce your taxes or increase your taxes, depending on what type of corporation you create.

There are two main types of corporations: “C” Corporations and “S” Corporations — and which type you choose can make all the difference in the world of taxes.

NOTE: The question of “C” Corp vs. “S” Corp has no effect on the asset protection provided by your corporation. This is a tax issue, not a legal issue.

A “C” Corporation can lead you into a Tax Trap known as “double taxation”. Yes, income from a “C” Corporation can actually be taxed twice — once when it’s earned on the corporate level and again when it’s paid to you, the shareholder, in dividends.

There are several ways to avoid double taxation. Often the easiest way is to tell the IRS that you choose to be an “S” Corp instead of a “C” Corp. The profits of an “S” Corp are not taxable to the corporation; instead, those profits are reported directly on the shareholder’s personal income tax return and are therefore only taxed once.

And once is enough, don’t you think!

Of course, any article on Choice of Entity must contain the old disclaimer, “Consult your tax professional” — I am not prescribing a one-size-fits-all approach to this issue. But for many small biz owners and self-employed folks, the “S” Corporation is a good fit because it provides protection from personal liability and avoids the nasty tax trap of double taxation — two great benefits worth checking into.

Should you incoporate your sole proprietorship and then decide that the “S” Corporation is the right fit, you must inform the IRS that your corporation is choosing “S” Corporation status by filing Form 2553, which is, in effect, an application to become an “S” Corporation.
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Congress has passed legislation that is supposed to result in a more “sensitive” Internal Revenue Service. You know, not such a lean, mean, tax-collecting machine.

Hmmm . . . . What do you think?

A few months ago, one of my clients (let’s call him Mr. Jones) got one of those IRS “love letters” requesting more information about his return, and the IRS wanted to meet with Mr. Jones in person to discuss the situation.

Mr. Jones (a local small business owner) was required to show up at the local IRS office with all his records. The IRS was questioning the legitimacy of several business deductions — and so the IRS was doing what it is allowed by law to do — demand that the taxpayer prove that those deductions were valid.

Turns out that Mr. Jones lost the audit and ended up owing the IRS a significant amount of money — the additional tax, plus penalty and interest for late payment of that tax. Why did Mr. Jones’ lose the audit? Mr. Jones made two “classic” taxpayer mistakes:

MISTAKE #1: “NO RECEIPT, NO DEDUCTION”

Mr. Jones lost several deductions simply because he didn’t have the proper documentation to prove the deductions.

What do I mean by “documentation”?

Well, if the IRS requires you to substantiate a deduction on your tax return, you must be able to provide written proof that the deduction really happened. The easiest way to prove a deduction is to hang on to:

a) The receipt or invoice, and

b) Proof of payment, which can be a canceled check, cash receipt, or credit card statement.

Mr. Jones reported numerous deductions for which he simply didn’t have the documentation. No receipts, no canceled checks, no nothing. Turns out that Mr. Jones was one of those “cash guys”. Maybe you know what kind of guy I’m talking about — he never wrote a check in his life, just carried a wad of cash around in his pocket. He paid for everything with cash, and never kept any of his receipts.

Every year he’d sit down with his wife and “remember” how much he spent on different things. No way to prove any of this, of course. He just had a “feel” for how much cash he had spent, and he had run his business for so many years that he just “knew” how much it cost to purchase certain things.

Well, this is the kind of taxpayer that the IRS loves! It really is true — if you can’t prove that you paid for something (with receipts, invoices, canceled checks, etc.), then you run the risk of losing that deduction in the event of an audit.

One of the most common questions I am asked by clients is this: “I know I paid for something, but I don’t have a receipt. Should I still report the deduction.”

My response is usually this: “You only need a receipt if you get audited.”

At first, people don’t know if I am joking or not. Well, I do make that comment with my tongue planted firmly in cheek, but there really is a lot of truth to it. If you don’t have the documentation to prove a deduction, you can still report the deduction (if you want), because you only have to prove the deduction if you get audited.

But if you do get audited, knowing that there are undocumented deductions on the return, be prepared to lose the deduction. Fair enough?
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Between global warming and massive increases in fuel prices, many people are reconsidering their transportation. Honda has two natural gas cars the IRS absolutely loves.

Honda Natural Gas Cars Issued Massive Tax Credits By IRS

In 2005, the federal government passed a new energy policy act that created tax benefits for the use of alternative fuel vehicles. Most people are generally aware of this given the fact they get a tax credit break when they purchase a hybrid vehicle. What fewer people know, however, is they get massive tax breaks if they purchase a natural gas powered vehicle such as a Honda Civic GX.

Buried within the language of the new energy policy act is the Alterative Motor Vehicle Credit. The AMVC goes well above and beyond the financial benefits granted to hybrid cars. The act defines four distinct areas where the IRS must issue significant tax credits. Those categories include fuel cell vehicles, advanced lean burn technologies, hybrid vehicles and alternative fuel vehicles. While most vehicles fall within the hybrid classification, new models are coming on the market that fall within the remaining three.
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An odd quirk in the recent legislation to extend the Bush Tax Cuts is giving IRA holders a huge break. For one year, and one year only, the income cap will be gone.

Convert To Roth IRA Regardless of Income – 2010

2010 may seem like a long way off, but something magical is going to happen then if you prepare for it. The recent legislation extending the Bush tax cuts contains a unique clause regarding the Roth IRA. Specifically, it contains language that makes the Roth IRA available to anyone regardless of their income, but only for one year.

A Roth IRA is a retirement account that offers a lot of advantages. The primary advantage is found in the distributions from the account. Simply put, they are tax free if a couple of requirements are met. First, the distributions must be made after you pass the age of 59 years and six months. Second, you must have owned the Roth IRA for at least five years. If you meet this test, the money is yours free and clear including all the gains you have made from your investments over the years.

The only criticism of Roth IRAs has to do with income caps. Simply put, a person with a modified gross adjusted income of $100,000 or more cannot convert an existing IRA to a Roth. While many people fall below this income cap, those that were just over it certainly have had a beef.
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