Category Archives: Tax Strategies

7 things to do when starting a business to avoid nasty surprises

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(also seen online at IRIS.xyz)

The only thing that hurts more than paying an income tax is not having to pay an income tax. Thomas Dewar

When you decide to start a business, taxes may be the last thing you think about. However, not realizing that you owe the self-employment tax as well as income taxes can lead to a nasty surprise when you file your taxes. This post is aimed at avoiding that costly surprise.

But, before we discuss the self-employment tax, there are other important steps to take when you become self-employed. Here are the 7 things to do after you start your own business to avoid nasty surprises:

Avoid nasty surprises – set up bookkeeping, form your entity, get licensed, buy insurance, and pay taxes

Bookkeeping – set up bookkeeping using software like QuickBooks (either online or on your laptop). You don’t want to be scrambling to find receipts at tax time or not be able to tell somebody if you are making money or not.

You can save time by downloading from your bank and credit card companies. If you set up things well, all income and every expense will be properly categorized for your profit and loss statement, or P&L. The P&L and balance sheet help you monitor your business to see how well you are doing and are essential for preparing your tax returns. The balance sheet will also come in handy if you need to apply for financing.

For all these steps, you may want to hire an accountant or speak to an attorney.

Entity – for many small businesses, being a sole proprietor is appropriate. You avoid paying corporate excise taxes and filing annual reports. However, if you have partners, you may want to form a partnership, corporation or LLC (details on choosing are beyond the scope of this post).

If your business involves risks that could lead to law suits, form a corporation or LLC to shelter your personal assets from liabilities of the business that insurance may not cover. Make sure that any actions you take for the business are in your capacity as an officer or manager – i.e., never sign personally.

Remember, you may want to consult with an attorney.

Get licenses, file annual reports and pay local taxes – certain businesses require a license to operate. Most entities are required to file annual reports. And, your city may impose taxes on the personal property in your business. Be sure to find out so you don’t owe penalties for failing to file and pay.

Buy health and other insurance – in addition to liability insurance, you will want to obtain health insurance if you are no longer working for another employer. You may get favorable treatment for this expense on your income taxes. You can also purchase insurance to cover damage to equipment, loss of data, identity theft and so on.

File payroll taxes – if you hire people to work for you and pay them over $600 per quarter in any year, you need to report the compensation. If they are independent contractors, you file a form 1099 with the IRS. If they are employees, you file a W-2 with the Social Security Administration. You also provide these forms to your people for the income tax filings.

You may need to withhold and remit FICA and Medicare taxes. Also, your employees may request that you withhold and remit federal and state income taxes (unless you live in a state that does not impose income taxes). Failure to withhold and pay to the IRS and state can lead to serious penalties.

Pay your income tax – one big shock for many who start a business is how much they owe in taxes. When you received a paycheck, you probably did not focus much on the fact that your employer withholds federal and state income taxes and FICA and Medicare taxes. And, you never had a chance to spend what was withheld.

However, when you run your own business, you have full access to the pre-tax income, so you must diligently allocate funds ahead of time so that you don’t come up short at text time. To avoid owing interest on the taxes due, you make estimated tax payments each quarter to the IRS and state.

Pay the self-employment tax – when you were an employee, your employer withheld FICA and Medicare taxes from your paychecks. The employer also contributed FICA and Medicare taxes on your behalf

When you become self-employed, you are responsible for both the employee and employer amounts. This tax is based on your net self-employment income

A lot to remember, right?

Maybe, but knowing and planning is far better than trying to scrape together money in April to cover taxes you did not expect.

Good luck with your new business!

In future posts, we will examine partnering with others, assessing your profitability, rules on deducting expenses, and entry into the real estate market.

Plan now to avoid surprises from the Affordable Care Act when filing 2014 taxes

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2014 was the first year Americans had access to health insurance options through the Affordable Care Act (the “ACA”). With this new access to insurance came the obligation to purchase it or face new tax consequences. If you opted not to buy health insurance in 2014, you may be faced with a penalty when you file your 2014 tax returns. Even if you did buy insurance through one of the insurance marketplaces, you may have new tax forms to complete and some surprises when it comes to your refund or tax bill.

For most taxpayers, the impact on their tax filing will be minimal, requiring those who were covered to simply check a box indicating they had insurance throughout the year. Those who received subsidies to purchase insurance and who later had increases in their 2014 salary may be required to pay back some of that subsidy. Those whose salary decreased may receive a larger than expected refund.

As these provisions are new to everyone, there may be confusion for taxpayers and tax preparers alike. Unfortunately, due to recent budget cuts, the IRS expects to be able to speak with only half of the people who call in for assistance.

While gearing up for the 2014 tax season, it’s helpful to understand some the most important provisions of the ACA:

  • 1. Exemptions: The ACA provided some exemptions that allow taxpayers to opt out of purchasing insurance without any penalties, including hardship, affordability and religion. There are different methods for applying for an exemption depending on the type of exemption you are requesting. To learn more, go to: https://www.healthcare.gov/fees-exemptions/apply-for-exemption/
  • 2. Penalties: Those who do not qualify for an exemption, were insured for only part of the year, or remain uninsured will be required to pay a penalty called “The Individual Shared Responsibility Payment.” The penalty is set to increase over the coming years, so compare not to see if it is more beneficial for you to pay the penalty or buy insurance. The Tax Policy Center has designed a calculator to help you determine your penalty is you opt to remain uninsured: http://taxpolicycenter.org/taxfacts/acacalculator.cfm.
  • 3. Reconciling: Those who purchased subsidized insurance on the exchanges received an advance on a tax credit. At the time of requesting the subsidy for insurance in 2014, the amount of the subsidy was calculated based on the taxpayer’s 2012 income. The amount of the subsidy granted will be reconciled in the taxpayer’s 2014 filing using the taxpayer’s actual 2014 income and that will affect the taxpayer’s refund or bill. Changes in an individual’s personal circumstances, such as divorce, marriage or a new child can also impact those numbers.

    • There’s still time to plan. Taxpayers facing a loss in premium subsidies because of an increase in income can reduce their income to qualify for the credits. For example, they can contribute to an IRA by April 15, 2015, for the 2014 tax year.

    Year-end tax planning – how to minimize the total tax paid in 2014 and 2015

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    This year, when projecting your potential taxes, you have to factor in the changes from 2013 that affect 2014 and 2015, which can be daunting. That is:

    • You have the standard plan: “defer income/accelerate deductions unless you are in the alternative minimum tax (“AMT”)” (see below).
    • But then you also have the new 3.8% surtax, with rules that do not play well with the others!
    • Finally, the tax rates changed again for 2014 (see the table below).

    If any of this is not clear, please ask questions.

    Can you act?
    To make your review of 2014 planning less daunting, take these separate steps: (1) ask “can you act?” – determine what you can do reviewing the “what can you act on” list below; then (2), if you can act on any of the items in 2014 or 2015 – moving from one year to the other, or delaying further – then ask “what impact does your acting have?” ; and finally, ask “what happens if I take all of these actions?” – determine the impact of all possible moves in concert, especially vis a vis the AMT. Preparing tax projections for both years is the best way to find out how to act most effectively to reduce taxes. It permits you to see which moves have the best results in which years, so that the total tax paid in the two years is minimized.

    What can you act on?
    Wages – Can you defer or accelerate between years or even convert income into deferred income, such as stock options, or income to be received at retirement? Can you convert compensation into tax-free fringes?

    AMT – the AMT is the 28% flat rate calculated differently than the marginal rate of up to 39.6%. If your deductions bring the regular tax down too low, the AMT kicks in, so that the deductions are wasted and need to be moved to another year, if possible. Otherwise, you will want to increase income for that year to “pull yourself out of the AMT.” The AMT exemptions amounts for 2014 are $52,800 for individuals and $82,100 for married couples filing jointly.

    The 3.8% Medicare surtax – This affects all income for 2014 and beyond, but only to the extent of the lesser of (a) net investment income or (b) the excess of modified adjusted gross income (“AGI”) over the threshold, which is $250,000 ($200,000 for single taxpayers). Investment income includes interest, dividends, capital gains, annuities, royalties and passive rental income but excludes pensions and IRA distributions. The 3.8% surtax must be covered with your withholdings and estimated payments to avoid penalties and interest. See our post at Update on the impact of the 3.8% Medicare surtax .

    Standard Deduction – up in 2014 to $6,200 for single taxpayers and married taxpayers filing separately, $12,400 for married couples filing jointly, and $9,100 for heads of household.

    Schedule A itemized deductions – can you shift income and deductions for the maximum benefit, given the income-based deduction thresholds?

    • //Miscellaneous// – only the amount above 2% is allowed on Schedule A. Miscellaneous expenses include items such as unreimbursed employee expenses, tax preparation fees and investment-related expenses.
    • //Other Deductions// – certain itemized deductions are phased out once your AGI exceeds $305,050 for married filing jointly ($254,200 for singles), so that your itemized deductions are reduced by 3%, on up to 80% of the deduction, for the excess of your AGI above $305,050 ($254,200 for single filers).

    N.B. – (a) many of the deductions affected by the phase-out are the ones not allowed in the AMT calculation and (b) investment interest is not subject to reduction on Schedule A.

    Schedule C income and expenses – can you defer or accelerate between years so that the net income falls in the best year?

    Investment income – can you shift interest, dividends, and capital gains? The tax rate on capital gains was as low as 0% in 2013, with a cap at 15%. However, that cap went up to 20% in 2014 for AGI over $457,600, for married filing jointly ($406,750 for single; $12,150 for trusts and estates). You net losses against gains, with up to $3,000 of an excess loss over gains being allowed to shelter other income and losses you do not use carry to the next year.

    Notes

    • (a) capital gains include the sale of a primary residence (above the $250,000 per owner shelter);
    • (b) if you sell to recognize a loss, and want to hold the stock again, be aware of the wash sale rule which bars recognition of the loss if you re-purchase substantially the same security within 30 days, even if it is in different accounts you own, including repurchasing in your IRA;
    • (c) an installment sale that spreads gain over several years; a like-kind exchanges involve investment property, which means you can swap, rent and later convert to residential; and
    • (d) purchasing mutual funds late in the year can lead to dividend and capital gains distributions where the mutual fund price changes but your investment does not, such that you have no economic gain for the distribution on which you pay taxes – you are effectively pre-paying taxes because you did not purchase after the declared distribution date.

    Investment income also includes passive income and losses (rental property, limited partnerships and LLCs). If you can re-characterize any activities as material participation rather than passive by grouping together to meet the material participation rules, you have a one-time election to regroup (see final regulations on when and how you elect issued early in 2014).

    Roth conversions – can you convert an IRA to a Roth IRA, so that future distributions are not subject to tax? Be sure to pay the tax with funds outside of the IRA so that the conversion has maximum benefit.

    Stock options – can you exercise a non-qualified option (“NQ”), which is treated as ordinary income, or instead exercise ISOs, which can be investment income (but create an AMT)? Disqualifying an ISO converts it into a NQ, so that you have control over the type and timing of the income.

    Required minimum distributions (“RMD”) – If you turned age 70½ in 2014, you can take a distribution in 2014 instead of next year to decrease your 2015 income – but the IRA distribution is not subject to the surtax so this would be done for the Schedule A phase outs (see below).
    A direct distribution from an IRA to a charity allows you to give up to $100,000 (per person) of your RMD and lower your AGI for purposes of determining taxes.

    Estate taxes – Federal Estate Tax Exemption for estates of decedents who die in 2014 is $5,340,000, up from $5,250,000 for 2013.

    Gifting – can you shift assets by gifting within the $14,000 per year/per person annual gift tax exclusion, or even by filing a gift tax return to use some of your unified credit now, so that income is in the lower tax bracket of new owner? You may want to combine this estate tax savings strategy with income tax savings ideas so that you shift an income-producing asset to someone in a lower tax bracket.

    Inherited IRA – be sure to divide an inherited IRA among beneficiaries to get the maximum life expectancy for RMD calculations for each.

    If you made it this far, I hope you have a good idea of your 2014-2015 tax plan, or else a set of questions to ask so we can help devise one for you! //Please contact us//.

    Federal Tax Rates for 2014:
    [[image:2014-federal-tax-rates.jpg|large|link=source]][[file:2014-federal-tax-rates.pdf]]

    2012 year-end tax planning – 2012 vs. 2013 tax strategies requiring action now

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    The goal for tax planning, as always, is to minimize the total that you pay for 2012 and 2013. However, this year is tricky. Here is why:
    First, if your 2013 income is expected to be over $250,000 ($200,000 for singles), you cannot just accelerate write-offs from 2013 into 2012 and defer income to 2013 because your taxes will be higher in 2013. There is a new 3.8% tax that works like this, for example: recognizing a capital gain in 2012 avoids that tax in 2013 and also reduces your 2013 adjusted gross income, which may keep it below the threshold for imposing that tax next year. (See below for more details on the new tax.)
    Second, regardless of who becomes President, Congress is likely to reduce the amount or value of itemized deductions. Thus, you may want to accelerate what you can into 2012.
    Third, as always, combine your tax planning with your investment strategies, such as tax loss harvesting and rebalancing (see explanations at the end).
    Last, there are other issues to review for 2012, including converting your Roth IRA; gifting to children and grandchildren for estate planning purposes (to use the $5 million unified credit); and funding college for children or grandchildren.
    However, if you will owe the alternative minimum tax (AMT), you may have to revise your strategy. Many write-offs must be added back when you calculate the AMT liability, including sales taxes, state income taxes, property taxes, some medical and most miscellaneous deductions. Large gains can also trigger the tax if they cost you some of your AMT exemption.
    The best tool for planning is to do a projection for both 2012 and 2013, then see what items you can affect to reduce the total tax for both years.
    Assuming you will not have an AMT problem in either year, then in 2012 you could:
    • Take a bonus this year to save the 0.9% for a high-income earner;
    • Sell investment assets to save the 3.8% tax next year so the gain or income is in 2012 (e.g., sales of appreciated property or business interests, Roth IRA conversions, potential acceleration of bonuses or wages);
    • Defer some itemized deductions to 2013 (but, be wary of the possibility that these will be capped in 2013 and can affect your AMT for either year);
    • Accelerate income from your business or partnership, depending on whether it is an active or passive business; and
    • Convert Roth IRAs in 2012 as noted above.
    Then in 2013 and future years, you could:
    • Purchase tax-exempt bonds;
    • Review your asset allocation to see if you can increase your exposure to growth assets, or add to tax-exempt investments, rather than income producing assets. Also, place equities with high dividends and taxable bonds with high interest rates into retirement accounts;
    • Bunch discretionary income into the same year whenever possible so that some years the MAGI stays under the threshold;
    • While we do not recommend tax-deferred annuities, they can help save tax now to pay taxes in the future when the payments are withdrawn. (These are not recommended due to high fees, illiquidity and often poor performance);
    • Add real estate investments where the income is sheltered by depreciation;
    • Convert IRA assets to a Roth. Even though the future distributions from both traditional and Roth IRAs are not treated as net investment income, the Roth will not increase the threshold income; and
    • Reduce AGI by “above-the-line” deductions, such as deductible contributions to IRAs and qualified plans, and health savings accounts and the possible return of the teach supplies deduction.
    Note, however, Congress has not finalized the 2012 rules. Some expected steps are:
    • An increase in the AMT exemption to $78,750 ($50,600 for singles), raising it from 2012 rather than dropping back to 2001 rates;
    • Teacher $250 supplies deduction on page 1 of 1040, as mentioned above; and
    • IRA $100,000 tax free gifts to charities.
    Here are the details on the 2013 tax increases, enacted to help fund health care:
    • A new 3.8% Medicare tax on the “net investment income,” including dividends, interest, and capital gains, of individuals with income above the thresholds ($250,000 if married and $200,000 if single);
    • 0.9% increase (from 1.45% to 2.35%) in the employee portion of the Hospital Insurance Tax on wages above the same thresholds;
    • Increase in the top two ordinary income tax rates (33% to 36% and 35% to 39.6%);
    • Increase in the capital gains rate (15% to 20%);
    • Increase in the tax rate on qualified dividends (15% to a top marginal rate of 39.6%).
    • Reinstatement of personal exemption phase-outs and limits on itemized deductions for high-income taxpayers (effectively increasing tax rates by 1.2%).
    • Reinstatement of higher federal estate and gift tax rates and lower exemption amounts.
    If these changes take effect, the maximum individual tax rates in 2013 could be as high as follows:
    2012 vs. 2013
    Wages: 36.45 vs. 43.15%
    Capital gains: 15 vs. 20%
    Qualified dividends: 15 vs. 46.6%
    Other passive income: 35 vs. 46.6%
    Estate taxes: 35 vs. 55%
    *Includes 1.45% employee portion of existing Hospital Insurance Tax.
    **Estate and gift tax exemption also drops from $5.12 million to $1 million, if Congress does not act soon.
    Explanations:
    Tax-loss harvesting:
    >Review your investments to find stocks, mutual funds or bonds that have gone down so that selling now will create a loss. This loss shelters realized gains and up to $3,000 of other income.
    N.B. – If you replace the stock, mutual fund or bond, wait 30 days or use similar, but not identical, item. Otherwise, the “wash sale” rules eliminate realization of the loss.
    Rebalancing:
    >review your asset allocation to see if any portion is over or under-weighted. Then sell and buy to bring the allocation back in line. However, if you sell and re-buy now, before a dividend is declared, you will receive a 1099 for a taxable dividend in the new fund for investment returns in which you did not participate.

    Thanks to the Kiplinger’s Tax Newsletter, Sapers & Wallack and others for ideas and information.

    Update on estate planning – what should you gift now?

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    Estate planning remains stuck in limbo. That is, after 2012, the $5 million credit for gift and estate taxes goes away and we could be back at a $1 million credit. Also, the generation skipping tax limit now at $5 million would decrease. Finally, the portability of estate tax exemptions between spouses expires, meaning that the survivor can no longer use any credit amount not used by the first spouse, which would allow more to pass on estate tax free.
    So far, Congress has taken no action. Many expect the 35% rate and a credit of at least $3 million to be the law for 2013 on. However, Congress failed to fix the estate tax for 2010 so nothing is certain.

    Planning: This means you need to review your estate plan, especially your gifting strategies, and act now to take advantage of the higher gift tax credit. You can gift up to $5 million of assets free of gift tax now, or $10 million for married couples. The benefit is that all future income and appreciation on these gifts is removed from your estate. The downside is that the gifts are irrevocable, so you must be certain that what you pass on now you will not need later.
    You always want to select assets that you expect will grow in value. If the assets decline, the strategy is frustrated. An example of what could go wrong is gift of a home at peak values that is now worth far less.

    Remember that you have the annual gift tax exclusion allowing you and your spouse can each give $13,000 per year to any individual without eating away at your gift and estate tax credit. And note: any payments made to colleges or hospitals for the benefit of another person are not counted at all. (No gift tax return is required for these excluded amounts.)

    How do you effectively structure the gift? Here are some examples:
    • Family limited liability company (FLLC): With real estate or business assets, you can transfer minority interests in the FLLC to children or grandchildren. You retain control and the amount you gift is discounted because the minority interests lack control and lack marketability. You will need an appraisal for the value and the discount.
    • Dynasty trust: This type of trust is designed to pass assets on multiple generations. Distributions can be made to the first generations, but they never actually receive a final amount – they rely on the trustee for any amounts to be distributed to them.
    • Grantor retained annuity trust (GRAT): This trust transfers assets to children after a specified term while retaining a fixed annuity. The amount you gift is discounted, because children do not receive it until the end of the term. If the amount transfers, you succeed in transferring a discounted amount that becomes worth much more to the next generation.
    • Qualified Personal Residence Trust (QPRT) Like the GRAT, your children receive your house in the future, so the value of the gift made now is discounted. You can even stay in the house after that term, but you have to pay rent, which is in effect another gift.

    One note of caution: some have expressed the concern that if Congress does not act, the IRS could try to take back the excess in some fashion. Be sure to consult with your estate tax advisor before taking any moves.
    We added gifting as a “to do” on the Finance Health Day page .