Posts Tagged ‘Tax’

No more federal tax deposit coupons (Form 8109-B) after 2010

IRS has issued proposed regulations which will eliminate the use of paper-based federal tax deposit coupons after 2010.

Under current regulations, taxpayers whose aggregate annual deposits exceed $200,000 must generally use electronic funds transfer (EFT) to make federal tax deposits. Depositors not currently required to use Electronic Federal Tax Payment System (EFTPS) for deposits may instead use the paper-based FTD coupon system to make a deposit by presenting a check and a federal tax deposit coupon to a bank teller at one of the financial institutions authorized as a government depository or a financial agent.

The proposed regulations require all deposits of the following federal taxes to be made via EFTPS beginning January 1, 2011:

–          Corporate income and corporate estimated taxes;

–          Unrelated business income taxes of tax exempt organizations;

–          Private foundation excise taxes;

–          Taxes withheld on nonresident aliens and foreign corporations;

–          Estimated taxes on certain trusts;

–          FICA taxes and withheld income taxes;

–          Nonpayroll taxes, including backup withholding;

–          Federal Unemployment Tax Act (FUTA) taxes; and

–          Excise taxes reported on Form 720, Quarterly Federal Excise Tax Return.

Some business paying a minimal amount of tax can, however, continue to make their payments with the related tax return, instead of using EFTPS.

The proposed regulations are expected to be finalized by the end of this year.

In early January we will send our business tax update letter to all business clients.  We will also post this update on our website.  If you are not already using the EFTPS system for tax deposits, watch for important information regarding this change in Treasury Department policy in our annual letter.

Tax impact of a Short Sale or Foreclosure on a Rental Property, Part 2

In my previous blog on this matter, I explained some tax exclusions available for debt forgiveness on a rental property used in trade or business.  Let me explain what qualifies as trade or business and then tell you what the tax impact is for rental properties that don’t qualify. Keep in mind, if you are insolvent, none of this matters.  Your insolvency will make all debt forgiveness a non taxable event. 

First, there is no definition provided by the IRS for the term “trade or business”.  But what’s new?  However, the courts have developed two definitional elements.  First, you have to be trying to make a profit.  You can’t buy a house with an outrageous mortgage and not collect enough rent to pay for it.   This commonly happens when parents buy a house for their kids and don’t charge the kids enough rent (and in some cases, no rent at all).  The second element relates to the scope of the activities.  If you only have one rental and collect net rents (meaning a management company handles all transactions and provides you with the monthly distribution of the net amount), then it is not truly a trade or business.  On the flip side, if you own 10 properties, you handle collecting rent, paying the expenses and managing the properties, that would likely qualify as a trade or business.  Now, making the determination for the situations in the middle… you’ll need to sit down with your tax preparer and look at the facts. 

So now you’ve determined that your rental property does NOT qualify as a trade or business.  What are the tax implications of the short sale or foreclosure? 

First determine if your loan is a recourse or nonrecourse loan:  A nonrecourse loan is one where the lender has no recourse against the borrower if the proceeds from foreclosure are less than the outstanding mortgage.

  • Nonrecourse loan is almost always the case of the ORIGINAL loan you took out to acquire the property.  The loan is secured by the property and has never been refinanced.
  • Recourse debt is usually the case when you refinanced the loan – regardless if you pulled out money or not. There are some limited cases in which a refinanced loan is not a recourse loan… you probably need a lawyer to figure it out for you. 

The easy one is nonrecourse debt.  The amount of nonrecourse debt forgiven in nonrecourse debt is NOT taxable cancelation of debt (COD) income.  Therefore, you only need to calculate the gain/loss on the property in which the total debt becomes the sales price in the case of a foreclosure. 

Example:

                Nonrecourse debt                                                         $300,000

                Basis (purchase less depreciation)                             (250,000)

                Gain                                                                           $  50,000

 The foreclosure is treated entirely as an exchange with gain.  There is no COD income, only gain or loss. 

Recourse debt is more difficult.  You must consider both cancelation of debt income and the income from disposing of the property.

  • If the fair market value (FMV) of the property is higher than the basis, there is a gain on the disposition of the property.(Example 1)
  • If the outstanding debt exceeds the FMV of the property, there is taxable cancelation of debt (COD) income.  In a foreclosure, the FMV of the property is always less than the debt forgiven. (you would have sold it if you could and saved your credit). (Example 2)

 Example 1:

                Recourse debt                                                                    $300,000

                FMV                                                                                    (275,000)

                COD income                                                                    $  25,000           

                FMV                                                                                     $275,000

                Basis                                                                                   (250,000)

                Gain                                                                                   $  25,000 

Example 2:

                Recourse debt                                                                    $300,000

                FMV                                                                                     (250,000)

                COD income                                                                     $  50,000  

                FMV                                                                                     $250,000

                Basis                                                                                    (275,000)

                Loss                                                                                  $  (25,000) 

As always, see a professional when considering your personal situation.

Two unprecedented tax planning opportunities for 2010

To:  All our Blogging Friends

From:  Paul M. Polito, CPA

Subject:  Two unprecedented tax planning opportunities for 2010

  1. Conversions of Retirement accounts to Roth IRA Accounts: 

I was recently asked to speak to a group of investors regarding Roth Conversions.  To prepare for the presentation I enlisted the help of our team to develop several financial and tax models to look at the economics for a 30 year age range.  To my surprise, with few exceptions, the investor was better off converting their retirement account to a Roth IRA than retaining their traditional tax-deferred retirement account.  Most of our clients could not make Roth contributions in the past because of a limitation based on Gross Income.  It was simply too low to work for most clients.  The gross income limit on Roth conversions is lifted effective in 2010. 

For those of you who are not familiar with Roth IRA accounts, these accounts are provide for non-deductible contributions, but the earnings inside the Roth account are never taxed; that means never taxed! 

Roth conversions are particularly attractive now that the estate tax is reinstated effective January 1, 2011.  If you pass away with a tax deferred retirement account (Qualified Plan, 401k, 403b, Traditional IRA, Simple IRA, etc.), the retirement account is includable in your taxable estate and your heirs pay tax on the income as they receive it.  The after tax yield to the ultimate beneficiary can be under 20% of the account value at death. 

We posted the hand outs for my presentation on our website which include financial models illustrating the after-tax benefits of Roth Conversions.  The greatest opportunity for a Roth Conversion is between now and December 31, 2010 because you have the option to pay the tax on the conversion in 2010 or split the conversion income between 2011 and 2012.  There is also the opportunity to use hindsight if the Roth account should decline in value to “recharacterize” the account back to a normal retirement account and avoid the tax.  If this is of interst to you, I suggest you call your tax professional before Thanksgiving to allow sufficient time.  See the article on our website with this link: Roth IRA Conversions.

2.  Exclusion of up to $10 million in capital gain on certain small business stock:

Effective September 27, 2010 through December 31, 2010 (a 95 day period) if you invest in a qualified small business as defined in the statute, and you hold the stock for at least five years, you can exclude up to $10 million from capital gain and, (and this is huge!) the exclusion is not subject to Alternative Minimum Tax!  This was part of a stimulus package but at a mere 95 days, it seems more like someone received a political favor!  If you have the opportunity to invest in a small business that qualifies, or, if you start a small business that qualifies, this could be the opportunity to save up to $2.8 million in tax.  This is ideal for start ups, Angel Investors, employees with opportunities to buy qualifying company stock, etc.  Also, if a family business is currently owned in an LLC or other non-corporate entity and there are plans to sell to the next generation, this could be a golden opportunity to reduce the tax cost of a transfer.  The rules are actually pretty generous.  Call your tax professionals for more information if this is of interest to you right away.  It takes time to set these plans and investments in motion.

Tax Impact of a Short Sale or Foreclosure on your Primary Residence

Chances are you know someone who has had the misfortune of losing their home, either by a short sale or foreclosure.  Five years ago, it was a very rare occurrence and quite embarrassing.  Today, while still a little embarrassing, it’s nothing to be ashamed of.  Everyone was trying to get their piece of the American dream.  We can point fingers all day long, but the fact of the matter is foreclosures and short sales are fairly common today.  It’s important to understand the tax impact of these events.  

The following information is for FEDERAL TAX ONLY.  Each state has its own tax laws.  Consult a tax professional in your state for assistance.  California actually conformed to the IRS rules starting in 2009 (with a few exceptions– see a professional

If the house being foreclosed was your principal residence, here is what you need to know:

  • There are two kinds of debt:
    • Acquisition debt – the original amount of the loan used to buy your house plus additional debt for improvements (from refinance)
    • Non acquisition debt – subsequent amount taken out of your equity (from a refinance) that was not used on your house for improvements (ex. Paid off credit cards, bought a car, paid for college, vacation, etc.)
  • The debt forgiven is considered to be cancelation of debt (COD) and is applied to the debt in the following order: first to the non acquisition portion, then to the acquisition portion. This means you will always pay tax on any portion of the debt that is NOT acquisition debt (unless you are “insolvent”).
  • COD on acquisition debt is not taxed (up to $2,000,000 for federal, $800,000 for California, both for married filing joint – half if single)
  • COD on non acquisition debt is TAXABLE 

Acquisition debt on second homes, vacation homes, business property or investment property does not qualify for this exclusion. 

Example: 

Bob and Ann purchased a home in 2004 for $400,000; they paid $10,000 in cash and borrowed $390,000 (acquisition debt).  In 2006, the home was worth $450,000 so they refinanced and took out and additional $20,000 to pay off their credit cards.  In 2009, Bob lost his job leaving them with a mortgage they could no longer afford.  They decided to go through a short sale and sold their house for $250,000 ($160,000 less than what they owed!).  

Of the $160,000 of cancelation debt, $20,000 will be included on their 2009 tax return as income.  The remaining $140,000 is not taxable income.  If they were in the 15% tax bracket, this is $3,000 in federal income tax. 

These are special tax rules that will only apply to COD income from your primary residence between  January 1, 2007 and December 31, 2012 (unless extended by Congress). 

I will address the effect of debt forgiveness on non principal residences (i.e. rentals) in another post.

DISCLAIMER: I can’t address every issue that would come up during these circumstances.  Please see a professional when preparing your income taxes if you have debt forgiveness, even if you normally do it by yourself.  Depending on your situation, claiming insolvency may be the better route for tax purposes.

A sale is a sale even for nonprofits…

 “Nonprofit and religious organizations are exempt from taxes including California sales and use taxes.” This is a common misunderstanding for nonprofit and religious organizations.  Although many nonprofit and religious organizations are exempt from federal and state income tax, there is no similar broad exemption from California sales and use tax. Nonprofits commonly conduct a variety of activities that are considered sales, therefore, requiring a collection/payment of sales tax. The following are a few scenarios to consider:

Sales of tickets for fundraising events when the ticket price includes amounts for meals consumed on-site: This gets tricky (See Publication 18). Generally, the business or organization that serves the meal at a fundraising event is responsible for reporting. Meaning, if the organization serves the meals at the event, it’s liable for the tax based on the ticket price for the meal. There is a specific exemption for “religious organizations” where tax does not apply to sales of meals and food when all of these conditions are met:

  • You sell the food at a social or other gathering you conduct.
  • You furnish the meals to raise funds for your organization’s functions and activities.
  • You use the proceeds to carry out those functions and activities. 

The tax exemption applies regardless of who serves the meals. If a third party serves the meals, the religious organization must provide a resale certificate in order to purchase the meals without tax. 

Sales of merchandise on the Internet, live auctions, and silent auctions: A sales transaction occurred to the highest bidder; therefore, sales tax is calculated based on the successful bid. For sales tax, it is the retailer’s legal obligation to collect and pay the tax. If use tax applies, it is the consumer’s legal obligation to pay the tax. 

Merchandise or goods donated by a donor where the donated items are resold by the nonprofit:  Generally, a sale has occurred and the Organization needs to collect sales tax from the buyer. There is certain exempt tangible personal property (See Publication 61).  For example, zoological society’s sale, purchase, trade, or exchange of certain plants and animals is exempt from sales and use tax when the following conditions are met:

  • Animal or plant is on the threatened or endangered species list in the CITES Appendixes
  • The buyer and the seller are nonprofit zoological societies.

For plants that are classified as “Food for Human Consumption”, there is no sales tax charged to the purchaser. (Ex. Selling an apple tree is tax exempt) 

Sale of artwork where the nonprofit (not a museum) is the consignee:  The collection of sales tax is based on whether the consignee has the power to transfer title “without any further action on part of the owner.” If the organization can transfer title of the property then they are required to collect the sales tax from the buyer otherwise it moves to the artist. 

Other considerations:  

Nonprofits that make three or more sales in a period of 12 months are required to hold a seller’s permit. Also, an Organization must present a signed Resale Certificate to the California retailer if it plans to resell the merchandise to generate income as a form of fundraising. Temporary seller’s permits are available (for example: where an annual gala is the only event in which sales tax is collected). 

In conclusion, it is not always clear whether a nonprofit entity is liable for collection of sales tax. Each situation has its own unique twist, so when in doubt contact a professional with any questions you may have.

What type of entity should I choose for my business? (Part 1)

One of the first decisions you have to make when starting a new business is the type of entity structure to establish.  There are many thoughts and questions that may run through your head.  “I don’t want to pay taxes” might be the first one.  First off, come to terms that you are going to pay taxes.  You live in this wonderful country we like to call America and there is going to be a small price to pay for it.  Hopefully Congress doesn’t get in the way and raise taxes… but I digress.  While you will pay taxes, assuming you are profitable – and profitability is the goal in business right? – you shouldn’t pay more taxes than necessary. 

The second question might be “How do I reduce my liability, I don’t want to be on the line for this?” You have some options, each offering a different level of liability on the owners.

The third though might be regarding the simplicity or complexity of the business structure.  You can spend a good chunk of change in lawyer fees for a more complex structure, or you can be cheap and give the lawyers nothing. 

You have to weigh the importance of these factors to your business and make a choice, hopefully the right one.  What is the right one?  Only you can answer that question.

On our website, we have a chart that gives a list of factors to consider when choosing an entity type for your business.  There’s a lot to consider and the chart can’t cover all the issues, but it’s a start.

There are five main entity structures to choose from:

  • Sole proprietorship (self employed)
  • C-Corporation
  • S-Corporation
  • General partnership
  • Limited liability company

This post will go through some (not all) advantages and disadvantages of the sole proprietorship structure.  Future blogs will go through the other structures.

ADVANTAGES:

  • Taxed once – all business profits and losses flow through to the sole proprietor (also disadvantages).
  • Formality is limited – there is relatively very little formality to starting a business as a sole proprietor.
  • Free to transfer interest – generally, you can transfer your interest in the business to another entity without cost.
  • Can use cash basis – for tax purposes (in most cases)

DISADVANTAGES:

  • Personal liability – the sole proprietor is personally liable for all business obligations.  This means you are sued personally if the business is sued.
  • Social security tax –profits are subject to Social Security and Medicare tax.
  • Life of entity – the business does not exist past the life of the sole proprietor.
  • Bankruptcy – there is no bankruptcy option for a sole proprietorship.  The owner must personally file for bankruptcy under Federal Bankruptcy Statutes.
  • Higher IRS audit risk – the IRS typically audits more individuals with a Schedule C (how you report your income and expenses for a sole proprietorship) than other business structures.  These audits are consistently productive for the IRS.
  • Only one owner – the minute you add another owner, you are forced to select a different entity structure.

 Always consult a professional when starting a business to consider all your options and the advantages and disadvantages of each.

Planning for our Kids’ Future

As any mom can testify, we often think about our kids’ futures.  While dancing with my baby son a few months ago, I had thoughts of him leaving me one day for another woman on his wedding day.  While his head was comfortably snuggled on my chest as we swayed to the music, I couldn’t help but think of the day that my head will be resting on his chest for the mother-son dance.  Tears anyone? 

I don’t think about his wedding day all the time, but I do think about his future.  What can I do now to prepare him for an unknown yet inevitable future?  No one even knows what the world will look like two years from now, let alone twenty!  What we do know is we can do our best to raise our children to be good citizens, hard workers, and kind men and women.  We can teach them the value of work and financial planning.

We can also begin to build a nest egg to be used to attend college, start a business or start a family; sometimes with pre-tax dollars.

 Here are a few ideas:

  • Purchase long term bonds that mature at college age
  • Buy a rental property that will have cash flow and a potential for high equity value once your kids are adults
  • If you own a company, gift your child money to buy equipment that your company uses and lease it to the company for high rental rates.
  • If your child has earned income, set up an IRA or Roth IRA account and gift them the contribution amounts
  • Set up an Education Savings Account

Of course you should always consult a professional when considering one of these options.  Each case has its own limitation and tax considerations which is too much detail for this conversation.

Which medical expenses are tax deductible?

Everyone in my family was sick this weekend.  Unfortunately I wasn’t able to fight it off.  What a bummer too, my four day weekend was ruined by a cold. 

If you are like me, you avoid the doctor as much as possible and self medicate when possible.  The question is, are these self subscribed medications a tax deduction?  In most cases, the answer is no.  Drugs and medicines that do not require a prescription to purchase are not deductible even if your doctor recommends you take it (like aspirin).  The exception is insulin. 

However, there are some expenses that may surprise you: 

Tax deductible:

  • Acupuncture
  • Air conditioner necessary for relief from allergies or other respiratory ailments
  • Treatment for alcoholism or drug addictions
  • Birth control pills
  • Chiropractor
  • Exercise program or weight loss program (but generally not food) IF doctor recommended as a treatment for a specific condition
  • Fertility enhancement
  • Medical supplies such as bandages, needles, crutches or diagnostic devises
  • Pregnancy test kit
  • Sex therapy at a hospital upon doctor’s advice (I think I’ll leave my comments to myself on this one)
  • Wig for the mental health of a patient with hair loss caused by a disease

Not tax deductible:

  • Cosmetic surgery (some exceptions – congenital abnormality, accident or disease including obesity)
  • Dancing lessons (even if recommended by doctor)
  • Funeral expenses
  • Health club dues
  • Illegal treatments or surgeries
  • Medicines purchased from another country (unless FDA approved to be imported legally)
  • Marijuana (even if legal in your state for medical treatment like California)
  • Maternity clothes
  • Teeth whitening

This is not a complete listing, only some items that are not obvious.  See the IRS Publication 502  Medical and Dental Expenses for further guidance.  There are limitations to taking a deduction for medical expenses.  I’ll leave that for another discussion.

Opportunities and Pitfalls in Organizing a New Business

Recently we received a call from an attorney incorporating a start up. 

His question was simple enough:  “I need to know how to quantify beginning capital for this corporation I formed on December 31, 2009; there is cash and IP (Intellectual Property) involved.”

Upon learning the facts, we determined the people that formed this corporation were about to step into a taxable event of over $3 million!  We were glad we got the call before it was too late!

The lesson to be learned here is that it is always a good idea to get expert advice when forming a new company.  It can be very complicated!  Believe it or not one of the first things to consider is the ultimate exit strategy.  Frequently exit strategy drives the decision regarding both the form and tax options of the new entity in formation.

For small businesses engaged in a “trade or business” there is an exit strategy benefit worth planning for: 

Shareholders of Corporations formed after 2/17/09 and before 1/1/2011 get a 75% exclusion from capital gains up to $10 million.  Previously this was 50% and at that rate it saved a ton of tax!  The corporation must be a C corp. from inception.  If you want to use this strategy but still pass the initial losses to the founders, start with an LLC and form the corporation when you get traction and investors.  If you hold the stock for 5 years before sale, you get the exclusion.  There are details and  limitations that are beyond this discussion.

When forming an entity with sweat equity and money, “sweaters“  beware !

If the money partner puts in property (and/or money) of $1 million and the “sweaters” put in labor for 50% equity, they realize taxable earned income of $1 million upon receipt of the stock.   Usually the money partners want “know how” or other  I.P.  If this situation fits, turn your “sweat” into “property”  before you receive stock.  You could save a fortune!   Written business plans, patents, laptops….all property!  Work for your equity……. Taxable! 

If the money partner puts in $1 million for 50% and the “sweaters” put in labor for 50%, they realize income of $1million upon receipt of the stock.  This can be devastating to starving start ups.

Finally, April 15th!

I have already had quite the morning.  My delicious protein smoothie spilled ALL OVER my car while driving in this morning.  REALLY?  That is how my day is going to start?  When are the car makers going to figure this out? MAKE DEEPER CUP HOLDERS!  I’m talking to Ford, GMC, Toyota – all car makers.  Do you not drive in your vehicles?  Do you not use the cup holders?  I know this isn’t in anyway related to accounting, but I thought I had to throw it out there.

So now that I’m starving, I’m eating an apple I packed in my lunch and counting on Paul bringing in Froggie’s doughnuts like he always does on April 15th.  The Polito family swears by these doughnuts.  Forget the diet for one day, I’m hungry.  The good thing is this day can only get better from here.  The partners are taking us out to a nice dinner tonight so at least I know it will end well.

Another tax season under the belt, the deadline has finally come.  It’s April 15th and I hope you have your tax returns or extensions filed.  Failure to file on time is a 5% penalty per month (maximum of 25%).  Keep in mind the extension is only for filing your tax return, NOT an extension to pay your tax (more penalties for not paying on time).  If you have a tax liability and do not pay the tax by TODAY, you will start racking up the interest and penalties.

What are we going to do?  Take some well deserved time off.  Our offices will be closed through Monday, April 19th.  We won’t be answering phone calls or replying to e-mails.  Don’t take it personally; we just need to catch up on sleep and family time.  We will be back to work on Tuesday April 20th.

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December 16, 2012–Richard and Joe welcomed Don Eppich of Polito Eppich. (Commercial free. 42 minutes.)

August 19th, 2012–Richard and Joe discuss tax policy and accounting services with Paul Polito, CPA and Don Eppich, CPA.

March 25th, 2012-Richard and Joe discuss the best accounting practices and strategic advice for businesses with Paul Polito, CPA and Don Eppich, CPA of www.PolitoEppich.com

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