Spring Cleaning, a Little Late

It’s hot as hell outside, and you just want to hibernate in the air conditioning. Trying to figure out what to do while you’re chilling out? How about organizing your tax records?! If you start organizing yourself now, come this tax season, you’ll be cool as a cucumber, and ready to make your favorite CPA’s day, with all of your organized records. IRS has some recordkeeping tips for individuals and small business owners.

What to Keep – Individuals

IRS recommends keeping records that support items on your tax return for at least three years after the return has been filed. Some of these records are bills, credit card and other receipts, invoices, auto mileage logs, canceled or imaged checks, and any other records to support deductions or credits claimed on a tax return. You should also keep records relating to property at least three years after you’ve sold or otherwise disposed of the property. Examples of this include a home purchase or improvement, stocks and other investments, IRA transactions, and rental property records.

What to Keep – Small Businesses

Similar to individuals, for small businesses, IRS recommends the three year timeframe for retention of business records. Examples of these include records that document gross receipts, proofs of purchases, expenses, and assets. These can include cash register tapes, bank deposit slips, purchase and sales invoices, credit card charges, Forms 1099-MISC, canceled or imaged checks, account statements, petty cash slips, and real estate closing statements. Electronic records can include databases, saved files, emails, faxes, and others.

IRS generally doesn’t require records to be kept in any special manner, but common sense would indicate that having a designated place to keep your tax records is a good idea. If you have all of your records in one place, it will make your job a lot easier when preparing to meet with your CPA, or if you should be one of the unfortunate souls who receives an IRS notice, or need to substantiate something for an audit.

The morale of the story is, even when it’s brutally hot and humid outside, you can be one of the coolest people around, when you have your tax records in order (at least this CPA will think you’re cool!). How organized are your tax records? Leave a comment, telling us the good, bad, and the ugly! Please forward this article along to anybody who you think needs to get their tax @#$% together.

Do I need an Outsourced CFO?

Whether you’re starting a business or are already established, you probably have many different concerns, including keeping costs under control, the instability of the economy and business climate, staffing/employee issues, and trying to figure out the best plan for your business’s future growth, profit, and security. Using an outsourced Chief Financial Officer (CFO) makes sense when considering all of these things. Below are some of the benefits of having an outsourced CFO on your team, as well as when to consider using such a service.

What Is an Outsourced CFO?

I’m guessing that we’re all familiar with the term “outsourcing”, regardless of whether that means somebody local or in another country. As it relates to CFO services, some of the more common services that an independent professional can do include preparing and analyzing financial statements (including balance sheet, income statement and cash flow). Additional services may include helping with future growth models and projections, assistance with a business plan, developing an operating budget, and more.

Benefits of an Outsourced CFO

Independent and Objective viewpoint: Unlike internal staff, an external consultant has no preconceptions or agendas in relation to the business agenda.

Creative solutions: Since many consultants have a breadth of experience in a variety of industries, they often bring a new perspective to operations that could be beneficial in the long run.

Networks: In many cases, an external CFO has connections in a variety of fields and industries that may benefit you, particularly for business growth.

When do you need an Outsourced CFO?

As I mentioned above, an outsourced CFO can help when starting a business, or during growth periods:

Start Up: Utilizing the knowledge of an experienced CFO to help you build the proper financial structure initially will pay off in the long run.

Business Growth: As the bookkeeping function starts to morph into something more than payroll, accounts payable, collections, billing, etc. a CFO is necessary to help the company with more advanced activities, such as financial statements and compliance.

Full-timer Is Unnecessary: There comes a time in every business when the financial portion of the company becomes more complex and begins to take up more and more time. However, there is also a gap between this period and the need for a full-time CFO. It’s during that gap when outsourcing CFO services makes the most sense.

Preparing Business Plans: Unless you have experience in this area, it’s best to work with a professional who knows how to prepare the documentation needed by funding sources.

Sounding Board: When a business owner seeks an objective, independent review of his/her business, having a dependable consultant to speak with may be invaluable, especially if it helps you to avoid a costly mistake later.

In the end, to determine if this model is right for your business, weigh the benefits against potential risks. Do your homework. Be diligent about keeping your finger on the pulse of your business and engaging with the chosen CFO through open and frequent communication. And if you’re in the Northern Virginia/DC metro area, contact me about CFO services.

As always, feel free to pass this along to others who may benefit from it, and if you have your own outsourced CFO experience, please share it!

Oh S#$%, I Screwed Up My Tax Return!

No…not me, my return is perfect! But if you’re one those people who got in over your head, trying to do a return on TurboTax when you had no idea what you were doing, or you had an incompetent tax preparer omit things from your return, it’s not the end of the world, and you won’t go to jail for it either! So take a deep breath, and read on.

It’s a fact of life that people make mistakes, even when it comes to tax returns. After filing your returns, you may discover that you forgot to claim all those charitable contributions you made, or you realized that you forgot to include the W-2 income (and withholdings) from that job you left at the beginning of last year, or the broker sent you a corrected 1099 package. These are just a few examples, but the point is, there are many things that you may remember (or come to your attention) after you already filed your tax returns. The vehicle for making the corrections is filing Form 1040X (Amended U.S. Individual Income Tax Return) with IRS. Don’t forget to amend your state tax return too. Not all states have a separate form for amending the original return, so check with the tax department of the state you live in, to find out how to do it (or have your favorite tax professional help you out!). Note that an amended return doesn’t have to be filed for reasons such as mathematical errors (IRS will probably catch those, and send a notice), or if you forgot to attach a form that you should’ve attached (they’ll let you know about this, too).

Form 1040X can be used to amend whatever original federal return you filed, meaning that if you filed Form 1040, 1040A, 1040EZ, or even 1040NR, you can use the 1040X to make corrections. The 1040X isn’t ‘year specific’ like the 1040 is, meaning there isn’t a 2011 Form 1040X, rather, there are boxes at the top of the form for you to check which year you’re amending. If you have multiple years to amend, you must submit a separate 1040X for each year, and check the year that you’re amending. IRS recommends (and I personally concur) that if you’re amending more than one year, put each year in a separate envelope. That way, if one year gets lost in the mail, they won’t all get lost.

The structure of Form 1040X is fairly simple. There are three columns; the first one is for entering amounts from various lines on your original return, the second one shows the changes you’re making, and the third shows the corrected amounts. In addition to the form itself, you must attach any schedules that have changed from your original submission. Using one of the examples above, if you omitted charitable contributions on your original return, you must attach Schedule A (Itemized Deductions) to your amended return, to show the change. In addition to any attachments, there’s a section on page 2 of the return where you need to put an explanation of why you’re amending the return. And continuing the above example, you would write something like “original return omitted charitable contributions of $100,000” (yes, you were very charitable!)

Depending on whether you’re amending the return to include income or deductions that were missed on your original return will determine whether you owe additional tax or you will receive a refund. It’s all determined as part of the computations on page 1. If you have a balance due, pay it with the amended return, and IRS will send you a bill for any interest or penalties you owe. If you’re due a refund, it’ll be mailed at some point, after the return is processed. IRS indicates an 8 to 12 week processing time for amended returns. The other thing to remember is that if you’re amending a return to claim a refund, you must file it within three years of the date you filed the original return, or within two years of the date you paid the tax, whichever is later.

The moral of the story is, if you screwed up your return, don’t fret; it can be fixed. And next time, think about having a competent, trained professional (like Jay the CPA) prepare your taxes.

Please share this article with others who may benefit from the wisdom contained herein(!) And if you’ve had any interesting personal experiences with amending tax returns, please leave a comment.

S Corporations and Reasonable Compensation

If you’re a small business owner, you may have heard the term “S corporation” or “S corp”. If you haven’t, then I’m guessing that you haven’t had a conversation with a CPA lately. Small businesses choose to make an “S” election to eliminate the self-employment tax on net income that a sole proprietor, single or multi-member LLC, or partnership would ordinarily be subject to. While there is this valuable tax benefit (13.3% for 2012) to being an S corporation for tax purposes, it’s extremely important to be aware that the savings on self-employment tax is not a giveaway by IRS, and if you’re not careful, it can cost you.

While it’s very tempting to just claim the net income from your S corp on your personal tax return, and only pay income tax (and no self-employment tax) on that income, IRS wants to see you pay yourself a “reasonable compensation” if you perform services for your S corp. If you’re the 100% shareholder and only person involved in your S corp, it would be difficult to claim that you provided no services for your own business, so you need to take a salary, the same way that you would pay a salary to an employee, since you’re in reality an employee of your own S corp. As such, you also become involved with filing quarterly payroll tax returns, making federal and state unemployment contributions, and issuing yourself a W-2 at the end of the year.

If you’re a small business that has made the S election, and are thinking “the heck with taking a reasonable compensation”, be advised that this is something that has seen a lot of noncompliance and abuse in recent past, and it’s on IRS’s radar. They’ve won many court cases on this subject, in spite of the fact that the Internal Revenue Code doesn’t explicitly define what “reasonable compensation” means, even though they’ve issued a fact sheet about compensation for S Corporation officers (just Google “FS-2008-25”).

Making an S election can be a source of significant tax savings, even with the additional costs of using a payroll service to issue paychecks to you and file payroll tax returns, and having a CPA prepare a separate tax return for the business (Form 1120S). It may be worth your while to invest a few dollars in having your tax professional run a side by side comparison of how much total tax you’d pay without having the S election vs. how much you’d pay with the election.

Please share this article with fellow business owners, and leave a comment on your own experience with being an S corp.

Tax Planning After Death?!

Did you read the title of the article and think that I lost my mind? How could a deceased taxpayer plan anything?! Of course they can’t, but the executor of the estate can use various tax planning techniques to save money, and minimize or shift the amount of tax that a decedent’s estate will pay. Here are just a few tips…

Select a Fiscal Year End-one basic thing to keep in mind when considering the taxation of an estate is that the assets held by a decedent when she/he passed away will generally continue to generate income after death. Think of any dividend paying stock or mutual fund, and you’ll see that dividends will continue to be paid, regardless of whether they’re held by an individual or an estate. An estate is one of just a couple of “tax paying” entities that has the ability to choose a fiscal year end, that is, a year end other than December 31. By picking a different fiscal year end, the estate can effectively defer tax on income retained in the estate, or on income distributed to beneficiaries.

Elect to Include Income From the Decedent’s Trust on the Estate’s Income Tax Return-as I mentioned above, an estate is able to choose a fiscal year end, while a trust must use a calendar year end. By electing to include the income from a decedent’s qualified revocable trust on the estate income tax return, the executor can effectively shift the income (and tax) from one taxable year to another.

Consider Distributions to Beneficiaries to Minimize Tax-this “tool” is almost a no brainer, provided there are no issues with an estate’s ability to make distributions to beneficiaries (such as assets tied up due to legal problems, or family issues). The tax brackets for an estate are so small that an estate will be in the maximum (35%) bracket at $11,650 of taxable income. By contrast, a single taxpayer doesn’t hit the 35% bracket until getting to $388,350 of taxable income. So if it’s at all possible, the estate’s income should be distributed out to the beneficiaries.

File an Initial/Final Return-o.k., even though this one potentially means less fees in my pocket, one thing an executor should consider is filing just one tax return for an estate, in which both the “initial return” and “final return” boxes are checked. For smaller estates that are able to take care of business quickly, and make all the required distributions, this is the way to go, since it will save having to file a return for a second year.

These are just a few of many things that an executor can do, to save tax money on an estate. Please pass this article along to anybody you know who may be dealing with an estate, and post any comments you may have, based on your own experience.

2012 Tax Planning

Summertime, and the livin’ is easy… You’re probably thinking about trips to the beach, and adult beverages with little umbrellas in them, but you know what I’m thinking about? Tax planning! Yeah baby, there aren’t many better ways to spend a summer day than thinking about saving money on your taxes. Well, maybe a nice cold beer wouldn’t hurt either!

If you recall back in 2010, there was a lot of uncertainty over tax planning, because nobody knew if the “Bush tax cuts” were going to be extended or not. Well, we’re in the same exact boat again, because the two year extension that was enacted in 2010 expires at the end of 2012. Plus ca change, plus c’est la meme chose…if you don’t understand French, just pop the phrase into Google. Or to quote Aerosmith, “it’s the same old story, same old song and dance, my friend”.

Here are a few things to consider this year

Roth conversions-if tax rates go up in 2013 (as Bush tax cuts expire), anybody considering making a Roth conversion should do it in 2012, while the rates are still lower. Then any future earnings will be tax-free (assuming Congress doesn’t eliminate Roths some time in the future).

Realizing capital gains-as with ordinary income tax rates, expiration of the Bush tax cuts will mean that the long-term capital gains rate will increase from 15% to 20%, so realizing gains in 2012 will mean less tax to pay on the gains. Any investment could then be re-purchased if desired.

Tax-exempt bonds-hand in hand with the possible tax cut expiration is the beginning of a new Medicare tax of 3.8% on investment income (interest, dividends, capital gains, etc) for people with adjusted gross income over $200K single/$250K married filing jointly. One way to reduce that is to move investments to tax-exempt bonds. The income on those isn’t subject to the Medicare tax.

Gifts-currently there’s a gift tax exclusion of just over $5 million. This is set to revert to $1 million in 2013 under the current law. What this means is that 2012 is the last chance to make a lot more gifts to children or others, without incurring gift tax.

Accelerating and deferring-the CPAs usual tax planning mantra is to advise clients to accelerate deductions and defer income from the current year to the following year. With tax rates set to increase in 2013, the opposite would hold true, that is, take the income now (so it’ll be taxed at a lower rate), and defer deductions (so they’ll reduce taxable income at a higher rate). Accelerate? Defer? Too soon to tell, but this is something to consider as year-end nears, and especially after the November elections, when both sides of the aisle will probably show their cards.

In summary, is there a lot of uncertainty when it comes to tax planning? You betcha. In spite of that, it’s always a good idea to think of these things sooner rather than later. Well thought out decisions are always better than knee-jerk reactions, and once the calendar turns over to 2013, a lot of planning opportunities will be gone, so while you’re sitting in that inflatable kiddie pool with a beer in your hand, be thinking about taxes, o.k.?

What are your thoughts about tax planning, or the end of the “Bush tax cuts”, or beer? Post a comment, and please forward this article to friends or colleagues who you think could benefit from it.

Miscellaneous Tax Stuff

Now that tax season’s over, it’s time to get back to other parts of life that got pushed to the side from January to April. One of those is writing articles for this blog. One thing I wrote about a number of months ago was ‘miscellaneous tax stuff’, and I think it’s time to do that again, so here goes…

Gift Taxes-did you know that if you make a gift of money or property to somebody else, you may need to file a gift tax return? You didn’t know that? Well, they say you learn something new every day, so you’re good to go! Check out a brief IRS YouTube video for more information, at http://www.youtube.com/watch?v=bPnR3U8Wk04

W-2 Reporting of Employer-Sponsored Health Coverage-beginning in 2012, employers must report the cost of group health coverage on employees’ W-2s (sent to employees by 1/31/13). IRS has more information at http://www.irs.gov/newsroom/article/0%2c%2cid=257101%2c00.html

Start Planning Now for Next Year’s Tax Return-it’s never too soon for tax planning. Here are some things you can think of now
-did you have a large overpayment or balance due on your 2011 tax return? You should think about adjusting your withholdings, to have less/more tax withheld
-organize your recordkeeping, to make it easier at tax time. I think that part of the stress people feel when it comes to taxes has to do with searching for information they need. If you have a set place to put all tax related papers, you won’t have to remember where you put everything. And keep your prior year returns nearby, too.
-if you’re close to itemizing deductions, think about “bundling” your deductions into one year. This could include making an early mortgage payment or paying property tax before its due date.
-start thinking about (JayTheCPA) finding a tax professional (JayTheCPA) sooner, rather than later. Did you like my subliminal advertising?!

Name Changes After Marriage or Divorce-if your surname changed due to marriage or divorce, check out this IRS YouTube video for more information http://www.youtube.com/watch?v=LibPOtwWAGc

Estimated Taxes-this is something that new business owners forget about, until it’s tax time, and they find out that not only do they owe a load of tax, but a penalty too, for not making quarterly estimated tax payments. Check out this IRS YouTube video http://www.youtube.com/watch?v=DM5XxKCATv0

I hope you found at least one piece of ‘stuff’ helpful to you. Please pass along this information to somebody else who may benefit, and let me know if you have any interesting tax stuff to share!

Mistakes Small Business Owners Make That Can Cost Them…DOH…The Sequel

O.K., I lied. Two weeks ago, when I did the first part of this discussion, I said that I’d post part 2 the following week. I’m a week late, but I’ve had other things on my mind, like tax season, and keeping my clients happy. I think I have a good excuse.

Anyhow, if you recall, a couple of weeks ago, I started talking about ways that small business owners can get themselves into hot water, and how to avoid it. The following are a few more things…

1-Filing tax returns late: When tax returns are filed late, penalties and interest will be computed on any tax due. This is applicable for payroll tax returns, sales tax, income tax, pretty much any tax that can be levied. Don’t be under the wrong idea that filing an extension for any tax return will keep you safe. An extension only gives you more time to file the return itself; it’s not an extension of time to pay any tax. The late filing penalty will cost you 4 ½% per month, late payment is ½% per month, and interest is 3%. Additionally, pass-through entities (S corporations, partnerships, LLCs), while paying no tax of their own, can be assessed a penalty of $195 for each late filed K-1.

“DOH!” Just take care of filing all of your tax returns on time, and you can avoid all of these charges. It’s so easy!

2- Penalties: While I’m discussing the above, let me tell you about other penalties that you can owe, when you deviate from the straight and narrow. To name a few-failure to deposit taxes, negligence, substantial understatement, accuracy related, failure to have JayTheCPA prepare your return…April Fool’s, just kidding about the last one!

“DOH!” The point I do want to make here is that you really don’t want to mess around with tax preparation, or fall behind in tax filings. The additional charges can add up really quickly, and all of them are completely avoidable, by taking care of things timely.

3-Home office deduction: Over the years I’ve had many clients tell me that they don’t want to claim a home office deduction for their business, because they think it’s a red flag for an audit. It’s not necessarily a red flag but the rules for claiming a home office deduction are specific, in particular the rule that the area in your house/apartment must be used “regularly and exclusively” for business. What this means is that if you’ve got a desk set up in the den, which your family also uses to watch TV, or you work at the dining room table, where the family also takes meals and entertains, that’s not regular and exclusive use.

“DOH!” If your work space fits into IRS’s requirements, not only will your home office deduction save you on income tax, but it’ll save you on self-employment tax too, which is currently about 13 percent. It’s a completely legitimate deduction that should be taken, when applicable.

4-Not using a CPA: It’s my blog, and I’m allowed just a little bit of self-promotion, right? Let me start this with a statement; I don’t know much about I.T., printing, banking, law, or medicine. Or lots of other things, for that matter. I’m not qualified to do any of those. How about you; what qualifies you to be a bookkeeper/accountant/CPA/tax preparer? Probably not much, which is why you should have a CPA as part of your professional team.

“DOH!” You can pay a CPA more later, to clean up the mess that you made with your taxes or your books, or you can pay less now to have a qualified bookkeeper help you with the books, and a CPA help you with the returns. You can try to use Google to research things yourself, but do you really have the time? Can you keep up to date with tax laws? Kids, don’t try this at home!

I hope you’ve found this and the prior installment of “DOH!” moments helpful. Please pass this information along to somebody who might benefit by these sage words of wisdom, so you don’t wind up looking like this little guy, after you’ve been spanked by IRS with penalties!

Mistakes Small Business Owners Make That Can Cost Them…DOH!

I was recently the presenter at a small business roundtable discussion that was geared toward small business owners. The facilitator asked me to discuss some mistakes that small business owners make that can cost them money, and to come up with a title. I gave it about a half second of thought, and realized that he already gave me the title, but took out ‘money’ and replaced it with the play on words (dough, and Homer Simpson’s cry when he does stupid things). My presentation lasted about an hour, and I won’t bore you that long, but hopefully some of these items will help you prevent your own “DOH!” moment.

1-Former W-2 employees becoming business owners/independent contractors: When you’re an employee, it’s so easy to just fill out your W-4, claim single-0, married-1, or whatever withholding exemptions, and the employer deducts the taxes for you and pays them in to IRS and the state. All you have to do is file your tax return and get your refund. This all changes when you become a small business owner or independent contractor. There’s nobody to withhold tax and pay it in for you; you need to do it yourself! If you’re an unincorporated entity (sole proprietor, partnership, single or multi-member LLC), you need to pay your taxes in to IRS and state on a quarterly basis, via estimated tax payments. Not only do you have to pay income tax, but on the federal level you also have to pay in self-employment tax.

“DOH!” You can be subject to underpayment penalties if you don’t pay enough tax in during the year. The penalty is 3% of the underpayment, and a late payment penalty and interest can be assessed if you’re not paid in full by April 15th. This “DOH” moment can be avoided with proper planning (with help from your favorite CPA, of course)

2- Employee vs. independent contractor: In this case I’m talking about the people you pay, to do work for you. If you pay somebody as an independent contractor, you give her/him a check for whatever the fee is, and at the end of the year, if you’ve paid that person $600 or more, you give her/him a 1099-MISC. When you pay somebody as an employee, you have to withhold taxes, pay them in to IRS and state, file quarterly payroll tax returns, issue W-2s, pay state and federal unemployment insurance and other benefits. What an expensive headache…makes you want to just pay somebody as an independent contractor, right?

“DOH!” IRS and the states have stepped up their scrutiny of the misclassification of employees as independent contractors, and are coming down hard. The determination of employee vs. independent contractor is ‘facts and circumstances’ driven, and you need to understand this, before potentially owing all sorts of penalties and taxes. This one can cost you BIG time.

3-Not making payroll tax deposits: Sometimes a business owner will have cash flow problems, and will skip making payroll tax deposits, which can be a significant amount of money.

“DOH!” Taxes withheld from employees are not the employer’s money, but are considered ‘trust funds’, and must be deposited on a timely basis. The penalty for failing to do this is 100% of the amount that was supposed to be remitted. What’s more, the “responsible person” for making the tax deposits (generally the business owner) can be held personally liable for any tax not paid. Don’t even think of not making payroll tax deposits.

There are a bunch of other “DOH!” moments that I want to discuss, and now that I’ve gotten into this, I think I’ll continue this next week. If you’re not embarrassed, please leave a comment about a less than bright decision you’ve made while running your business, and please forward this article to anybody you know who could use some good advice. Stay tuned for part 2 next week.

AMT…WTF?!

Once upon a time, high income taxpayers were able to pay little or no income tax, because they were able to take deductions and credits for things that the average taxpayer couldn’t. IRS created the Alternative Minimum Tax (AMT) in 1969, in attempt to eliminate some of the benefits of all the deductions that high income taxpayers were getting, and generate at least some amount of tax.

The major problem with the AMT (and IRS recognizes it) is that it’s not indexed for inflation, so over the years, more and more middle-income taxpayers are finding that they’re owing more tax based on the AMT. I’ve seen this countless times over the years with my clients, and have had the same conversation with many people, often with the conversation starting out with the title of this article!

The AMT is computed on Form 6251. Generally, the computation starts with your adjusted gross income (AGI) less your total itemized deductions (line 41 of Form 1040). From this number, “alternative minimum taxable income” (AMTI) is computed, generally by adding back certain deductions that are allowable for the regular tax computation. For most taxpayers, the ones that come up most often are the itemized deductions for taxes and the miscellaneous itemized deductions. There’s a long list of other deductions and “tax preference” items that need to be added back to arrive at AMTI, but they’re beyond the scope of this article.

After arriving at AMTI, taxpayers are allowed an exemption amount, and the remaining amount will generally be subject to a tax rate of 26 or 28% to come up with the tentative minimum tax. Once this tax is computed, the amount is compared to the regular tax on the Form 1040, and if the minimum tax is higher, than bingo, you lose, and wind up with the AMT.

The 2011 AMT exemption amounts are $74,450 for married filing joint taxpayers, $48,450 for single and ‘head of household’ taxpayers, and $37,225 for married filing separately taxpayers. If your taxable income for regular tax purposes is higher than these exemption amounts, the AMT may apply to you, and you need to fill out Form 6251 to see if you are in the AMT.

I’ve attempted to make this as understandable as possible. If you think you might be in the AMT, it would probably be a good idea to have a tax professional prepare your taxes. Please pass this article along to your fellow taxpayers, and leave a comment if you’ve had a ‘run-in’ with the AMT.

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