Archive for May, 2012
Over the course of my career, the most frequent conversation I’ve had with prospects and clients alike deals with what entity they use should to operate their new or existing business. This is going to be the subject of my first special report so if you haven’t subscribed yet, I highly recommend you do because it’ll be out in the next week or two. For now though, what I’m going to touch on is probably one of the more interesting aspects of utilizing an S-Corporation over a limited liability company (LLC) and that’s the potential to save on payroll taxes. I hate to use the word loophole because this specifically in the Code but it’s also something Congress has been trying to “fix” so be sure if you take advantage of this, you keep up to date on what is happening. There have been two attempts to slip “fixes” into other legislation but both times they’ve been knocked down.
What am I talking about? If you operate under an LLC, the earnings from your business is subject to self-employment tax which in 2012 is 13.3% (this is set to go back up to 15.3% in 2013). If you operate under an S-Corporation, you’re required to pay yourself a “reasonable” salary (we’ll get back to that) but the same earnings that were subject to self-employment tax by using an LLC aren’t there under an S-Corporation. Of course, the amount you pay on your “reasonable” salary is subject to those same taxes so you lose any benefit on that amount.
So let’s look at an example. Keeping it simple, your company makes $100,000 (net taxable income). Using an LLC, if you owned this business 100%, you’d have to pay income tax AND self-employment taxes on this amount. Now say this same company is using an S-Corporation structure and your salary is $50,000. Now you’re paying income and payroll taxes on the $50,000 salary but only income taxes on the remaining $50,000. The net effect is about a $6-$7k tax savings. Not too bad.
Now let’s get to the downside. First off, you’d better be able to justify your “reasonable” salary. If you’re the sole owner and the sole employee, there can be an argument that the entire $100,000 should be your salary. This is where you want to document why you’re doing what you’re doing. Maybe the average salary in your area is $50,000 and you’re using the rest of the money to reinvest in the business at a future point in time. Be ready to justify the amount. If you have employees, it gets easier to justify a less then 100% salary because then there’s aspects of the business that can more easily be considered a distribution on an investment (i.e. your business).
S-Corporations are also more administratively burdensome. Since you’re on the payroll, you have deposits to make and quarterly as well as annual payroll filings. That by itself can chew up some of that tax savings in either time or money. You’ll also have to pay unemployment tax. So in short, an LLC is easier, but if you operate under an S-Corporation and can justify a salary less then the full amount the company makes, there can be some tax savings there.
The Internal Revenue Service is finding ways to cut it costs and yesterday it announced that it was closing 43 smaller offices over the next two years. Apparantly this is going to save the IRS $40 million dollars but the bigger questions is, what does it mean for you.
The offices that will be closed are those with fewer than 25 people and that also don’t have a taxpayer assistance center. If you live somewhere more rural, you might see a change in where a notice comes from. There’s also going to be consolidation of some other offices. In my opinion, this means you’re going to see more and more desk audits. The more the IRS automates things, the more you’ll probably find that you won’t even see an agent if you get a notice. That is unless you owe money then you can probably expect a visit of some kind.
The IRS recently put out IR-2012-53 which is an expansion on their “Fresh Start” initiative that’s being billed as a way for financially disadvantaged people to clear up their tax problems. This new announcement focuses on the financial analysis the IRS is going to use to determine whether people qualify for an offer in compromise. Now, the IRS will only look at one year of future income for offers paid in five or fewer months and this is down from four years and they’ll look at two years of future income for offers paid in six to twenty four months and this is down from five years. There’s also an expansion of the allowable living expenses allowance.
What does all of this mean? It means that more people should qualify for offers in compromise and of those that do, the offers should come with lower numbers for taxes paid. If you owe back taxes and you’re in a tough spot, I highly recommend you talk to a tax professional. I wouldn’t necessarily go with someone who advertises on the radio but this is something where you might want to get an extra opinion on.
This came up recently so I figured it’d be worth a quick blog post. Here in May, one of my clients realized he had given me an incorrect amount on a 1099-MISC. In order to fix it, here’s the appropriate steps.
1) Contact the person or business in question. This is more of a courtesy but you want to let them know that the 1099-MISC is wrong and that you’re going to amend it. If they filed their return, it means they’ll have to amend as well. If they’re lucky enough in this case to have extended, then you can provide him with a fixed 1099-MISC.
2) When you’re printing off the new 1099-MISC, you check the box at the top to indicate it’s corrected
3) Prepare a new 1096 (don’t mark it in any way) for just the one 1099-MISC.
4) Mail the corrected Form 1099-MISC along with the new 1096 to the Internal Revenue Service.
Nothing too exotic here.
If you’re a regular to this website, you’ll notice something new. At the top of the sidebar by entering your name and email address, you’ll be able to receive my new monthly special reports. These will include timely summaries of new tax legislation as well as checklists and lists and you can’t beat the price because these will be sent to you inbox for no charge. Expect the first on in the first week of June and until then, be sure to enjoy the updates on the site.
Last week we talked about capital gains and this week, we’re going to talk dividends. This year, most dividends will be taxed at the capital gains rate which maxes out at 15%. If nothing is done, that special rate goes away and dividends will be taxed at your marginal tax rate which could go as high as 39.6%. If you thought the 5% increase on capital gains is big, managing your dividends if you’re able to is an even bigger deal.
For a lot of people with stock investments, there is no control over the dividends. You can opt to move to stocks that pay no dividends and you might see some of that. Where this rate change will really see an effect is if a person owns a C-Corporation or has an S-Corporation that has some C-Corporation earnings and profits. If you do and you have some cash sitting around, you might want to look at pulling it out as dividend. I wouldn’t do it until after the election although you can get an idea on what the political climate is going to be like, but until then, you have some time to assess the situation.
With a new year we get new luxury automobile depreciation limits. You have code section 280F to thank for this one and you can find the new limits in Revenue Procedure 2012-23. For passenger auto’s, the 2012 limit is $11,160 if the bonus depreciation rules (168(k)) apply. For trucks and vans, the limit is $11,360. If the bonus depreciation rules do not apply, the limit for passenger cars is $3,160 and the limit for trucks and vans is $3,360.
Doing a cost segregation study could be a beneficial exercise for a company that owns real estate but the Tax Court recently dealt a blow to those looking at a cost segregation study on assets acquired in an asset acquisition. While usually more beneficial to the purchaser because the goodwill is amortizable for tax purposes, one of the exercises of an asset purchase is Form 8594 which basically makes you pool the assets purchased into buckets based on their character. The Form is then filed with both the seller’s and purchaser’s tax return.
Putting a little extra time into Form 8594 is even more important now because of the Peco Foods Tax Court Case. What the tax court determined was that the allocation done on Form 8594 is binding and that you’re not allowed to subsequently do a cost segregation study on the assets that were purchased. You’re not even allowed to elect a Change in Method of Accounting on Form 3115 to effectuate a change in the allocation so once the Form 8594 is done, you’re stuck.
The moral of the story is, take the extra time to get this allocation done and as much to your benefit as you can. You can usually work with the seller to get a solid allocation done that helps both of you so put in the extra time either during the negotiations or once the sale is getting close to being finalized because the final allocation could have ramifications for years to come.
The year 2012 and leading into the year 2013 could be potentially the most challenging year I’ve known to do tax planning. We have several provisions expiring, we have an election year and we have a fractured Congress. Word on the street is that very little in the tax arena will be addressed until after the election so we’re looking at November and December to get changes or renewals done before the end of the year. Based on the current tempo of government, I’d bet we’re hung out to dry but I’ll be looking at some of the rules and how they’ll change if nothing is done.
First we will be looking at the long term capital gain rate. Right now, the tax rate on long term capital gains is 15% and it’s zero if you fall into the ten or fifteen percent tax bracket. If there is no action and the current provision expires, the long term capital gains rate will go up to 20% and it will be 10% if you’re in the fifteen percent tax bracket (the ten percent bracket will also go away).
What does this mean? You really want to look at your capital gains transactions at the end of the year. You might want to accelerate the gain on a stock you own to get the better rate and you also might want to defer any losses until 2013 since they’ll be more valuable. If you’re out of basis in your S-Corporation stock and you want to pull some money out and take the tax hit, you might want to do it sooner rather then later to get the better rate as well. You also might want to put off a like kind exchange and pay the tax on a transaction knowing this might be as low of a tax rate as you’re going to get.
As always, talk to a tax professional but if you’re sitting on some gains, you want to be extra careful and do a little bit more planning this year than in any other year I can think of.
Cancellation of indebtedness (COD) income has become a bigger issue in the past few years then I ever remember it being. At its core, if you take on debt and that debt is subsequently forgiven, you should be taking the amount of debt into your tax return as income. It seems harsh because usually debt is cancelled because of a hardship but the good news is, there a couple of different exclusions that mean when you get a 1099-A (Acquisition or Abandonment of Secured Property) or a 1099-C (Cancellation of Debt) you should be talking to a tax professional. If you ignore it, the IRS will come back at you (I know because I’ve helped people fix this when they’ve gotten a notice) but you also don’t want to just take the full amount reported as income and pay the tax either.
The first major exclusion addresses the foreclosure crisis and was part of the Mortgage Debt Relief Act of 2007. The provision basically says that if debt was forgiven on your purchase of a principal residence, you can exclude up to $2 million of COD income if the debt was forgiven between 2007 and 2012 (expiring soon). In order to qualify as your personal residence you have to had lived there for two or more years out of the last five. Also be careful because this usually includes just the amount on the original note. If you refinanced at some point and pulled cash out, then that debt might not qualify (again, be sure to talk to a tax professional) so it’s not as easy as just ignoring anything related to your home.
The next major exclusion is a four parter detailed in Code Section 108. The four exclusions are for
1) a debt discharge in a bankruptcy action under Title 11 of the U.S. Code in which the taxpayer is under the jurisdiction of the court and the discharge is either granted by or is under a plan approved by the court.
2) a discharge when the taxpayer is insolvent outside of bankruptcy
3) a discharge of qualified farm indebtedness
4) a discharge of qualified real property business indebtedness
Okay, take a breath. The exclusion most people will fall under is number two. The short explanation is, if you have a debt that’s cancelled and you’re insolvent (liabilities are less then assets and you get to take into account the debt that was forgiven), you can exclude the debt. It get’s tricky when you have multiple COD events (i.e., you have three credit cards and their forgiven at certain times) and in that event, as your liabilities come down, you might find yourself paying tax on some of the COD income. And I’ll say it for a third time, but when you’re working in this arena, be sure to talk to a tax professional.
UPDATE – The provision that lets you excluded cancellation of indebtedness income on your personal residence was extended through the end of 2013.