Five Tips For Starting A Business

One of the keys to starting a successful business is to understand the tax implications of operating a business, and selecting the right business structure to provide the best possible tax treatment for you. Starting a business involves more than just income taxes. Depending on the type of business you’re operating, and whether or not you have employees, you may be subject to a variety of additional taxes — some of which you may have never even heard of!

To help you get started on the right foot, here are five things that you should bear in mind before you even start your business:

Business Structure. An early choice you need to make is to decide on the type of structure for your business. The most common types are sole proprietor, partnership and corporation. The type of business you choose will determine which tax forms you file, which leads us to…

Business Taxes. There are four general types of business taxes. They are income tax, self-employment tax, employment tax, and excise tax. In most cases, the types of tax your business pays depends on the type of business structure you set up. You may need to make estimated tax payments if you are operating as a sole proprietorship, which is the exact same thing as being “self-employed” or operating what you may have heard referenced as a “Schedule C business”. These terms all reference the same business structure.

There are many disadvantages to operating as a sole proprietorship. From a tax perspective, this is a more expensive way to operate. You can reduce both your tax burden and liability risk by operating through another type of entity, such as an LLC or subchapter-S corporation. The process and considerations for choosing the entity structure that is best for you is a bit more complicated than what we can cover in this short article, so be sure to contact us for assistance with this.

Employer Identification Number (EIN). You may need to get an EIN for federal tax purposes. Even if you are operating your business as a sole proprietorship, you may still need an EIN for certain reporting purposes. For example, if you have employees in your business, you will need an EIN for filing quarterly payroll tax returns. You obtain an EIN by filing IRS Form SS-4, which can be done online or via mail. Please contact our office if you would like assistance in completing this form.

Accounting Method. An accounting method is a set of rules that you use to determine when to report income and expenses. You must use a consistent method. The two that are most common are the cash and accrual methods. Under the cash method, you normally report income and deduct expenses in the year that you receive or pay them. Under the accrual method, you generally report income and deduct expenses in the year that you earn or incur them. This is true even if you get the income or pay the expense in a later year.

Most small businesses that are primarily service providers will use the cash method, which is far simpler and requires less accounting work to maintain your books. You may use the cash method up until you reach $5 million in annual revenue.

If you maintain an inventory of products for sale, then you must, unfortunately, use the accrual method of accounting. While cash accounting is straightforward and easy to understand for most people, since it’s the same method we use for our personal finances, accrual accounting has a whole new set of strange rules that govern when income and expenses are reported. If you are required to use an accrual method, it is highly suggested that you use the services of an accounting professional to help you with this, even if that’s only on a quarterly basis to review and reconcile your books.

Employee Health Care. Regardless of your feelings about the Affordable Care Act (ObamaCare), the fact of the matter is that the law is here and something we must contend with. Under this law, Applicable Large Employers (ALE) are required to provide health insurance to all eligible employees, or face tax penalties for not doing so. If you have more than 50 Full Time Equivalent (FTE) employees, then you are subject to this mandate.

If you have less than 50 full time employees, but still wish to provide health insurance to your employees, the law actually provides an incentive for you to do so. The Small Business Health Care Tax Credit helps small businesses and tax-exempt organizations pay for health care coverage they offer their employees. You’re eligible for the credit if you have fewer than 25 employees who work full-time, or a combination of full-time and part-time. The maximum credit is 50 percent of premiums paid for small business employers and 35 percent of premiums paid for small tax-exempt employers, such as charities. For more information on your health care responsibilities as an employer, feel free to contact us for an appointment.

Cheapest Tax States To Reside In

Choosing to reside in a state with low tax rates can be an effective way to reduce your cost of living, often by a double digit percentage. State taxes come in a variety of forms, including income, sales, real estate, and personal property taxes. All states charge at least one of these taxes, and most charge all four to varying degrees. Your lifestyle will often dictate which type of tax is most critical for consideration when evaluating where to live. In this article, I’m going to present four states that offer different tax benefits for residents.

Alaska
Alaska has the lowest overall tax burden per resident of any state in the Union. Alaska is one of only two states that has neither a state income tax nor a state sales tax. Local municipalities in Alaska are allowed to levy their own local sales taxes, which can be as high as 7.5 percent, although many towns do not levy a sales tax. Alaskan property taxes are on par with the national average. Because of oil revenues to the state, Alaska is the only state that actually pays residents for living there. Alaska Permanent Fund Dividends vary each year, and were $878 per eligible resident in 2012.

New Hampshire
New Hampshire is the other state with no state sales tax and no state tax on ordinary income. The state does levy a tax on dividends and capital gains, so individuals who earn a large portion of their income from these sources should take this into consideration. Local municipalities in New Hampshire do not have sales tax, but New Hampshire’s state and local property taxes are the highest in the United States. Therefore, New Hampshire can be a zero tax state if you are a wage earner and do not own property.

South Dakota
While South Dakota does levy a 4 percent state sales tax, and local municipalities may also levy sales taxes, South Dakota has the second lowest overall tax burden for residents of any state. This is primarily because of the lack of a state income tax, and some of the lowest personal property taxes in the country. However, while real property tax rates exceed New York state’s, low property values statewide keep the actual property tax bills low. South Dakota is one of the most popular residency states for full time RVers that don’t own real estate, and is growing in popularity as a “tax home” for Americans living abroad for extended periods of time.

Nevada
Like most low-tax states, Nevada lacks a personal income tax. The state’s 6.85 percent state sales tax, with up to an additional 1.25 percent tacked on in some municipal areas, makes Nevada less attractive in comparison to other low-tax states. Nevada is unique among all states in that it charges property taxes on only 35 percent of the assessed value of property. Of particular interest to retirees, Nevada will rebate up to 90 percent of property taxes paid by those over age 62 who meet certain income criteria, making Nevada particularly attractive to retirees who engage in limited shopping.

Conclusion
While there is no one perfect state in regards to taxation, some states are definitely more attractive than others. Factors such as whether you will own a home or not, and how you earn your income, are important factors in determining whether one state or another is better for your situation.

The Tax Shelter Over Your Head

Home prices, which had been on a tear, have leveled out and even fallen in places. The housing “bubble” definitely appears to be over. So, the question becomes: Is real estate still a good place for your money?

Despite uncertain real estate prices, buying a house is still a smart choice for most families. Buying, rather than renting, replaces nondeductible rent with deductible mortgage interest. You can borrow tax-free against your home’s growing equity. And you can still sell your home for up to $500,000 profit, tax-free. This particular capital gains tax break isn’t likely to disappear in 2013, despite all the rhetoric about classic tax breaks disappearing.

Mortgage Interest

Tax-deductible mortgage interest is a cornerstone of tax planning for many families. You can deduct interest on up to $1 million of “acquisition indebtedness” you use to buy or substantially improve your primary residence and one additional home. You can deduct interest on up to $1 million of construction loans for 24 months from the start of construction. (Interest before and after this period is nondeductible.) Plus, points you pay to buy or improve your primary residence are generally deductible the year you buy the home if paying points is an established practice in your area. This deduction, while discussed as one that could get the axe by Congress, is too politically sensitive to actually be taken away from American voters in 2013.

Home Equity Interest

You can deduct interest you pay on up to $100,000 of home equity loans or lines of credit secured by your primary residence and one additional residence. Using home equity debt to pay off cars, colleges, and similar debts lets you convert nondeductible personal interest into deductible home equity interest.

Make sure you compare after-tax rates before you refinance consumer debt with home equity debt. If you can buy a car with a special interest rate, your nondeductible personal interest may still cost less than deductible home equity interest. If you can transfer a credit card balance to a new card with a low introductory rate, you could save money and avoid the paperwork needed to refinance your home.

If you pay points to refinance your home, you can’t deduct those points immediately. However, you can amortize them over the life of the loan. If you pay off the loan before fully deducting your points (including refinancing with a new lender), deduct the remaining balance the year you retire the loan.

You can still deduct the interest you pay on home equity balances over $100,000 if you use the proceeds for a deductible purpose. If you use home equity debt to buy stocks, for example, you can deduct it as investment interest; if you use it to finance your business, you can deduct it as a business expense.

Property Tax

You can also deduct property taxes you pay on your primary residence and vacation homes. Microsoft founder Bill Gates can deduct over $1,000,000 he pays on his Seattle-area compound. But be aware that property tax deductions may be limited by the AMT.

Tax-Free Income From Selling Your Home

The Taxpayer Relief Act of 1997 made important changes when you sell your primary residence. The old law, effective for sales before May 5, 1997, let you roll unlimited gains into a new home and offered a one-time $125,000 exclusion if you sold your home after age 55. The new law lets you exclude up to $250,000 of gain ($500,000 for joint filers) every two years, with no need to roll your gains into a new home.

You can exclude $250,000 if:

  1. You owned the home for two of the last five years,
  2. You occupied it as your primary residence for two of the last five years, and
  3. You haven’t used the exclusion within the last two years.

You and your spouse can exclude up to $500,000 if:

  1. Either of you owned it for two of the last five years
  2. Both of you used it as your primary residence for two of the last five years, and
  3. Neither of you has used the exclusion within the last two years.

You can exclude part of your gain (calculated by dividing the number of months you qualify by 24) without meeting that two-year minimum, if your move is due to:

  • Change in employment (you, your spouse, a co-owner of the house, or any other person whose principal abode is in the home accepts a job whose location is at least 50 miles farther from the home than their previous place of employment);
  • Health (a qualifying person or their relative moves to treat a disease, illness, or injury or to obtain or provide medical care for a qualified individual); or
  • “Unforeseen circumstances” (including, but not limited to, involuntary conversion, natural or man-made disaster, or a qualifying individual’s death, unemployment, change in employment or self-employment status, divorce, or multiple births from the same pregnancy).

Taking advantage of the tax shelter over your head won’t guarantee gains. You have to consider how long you will own your home, the cost of maintaining and repairing it, and the eventual cost of selling it. But the tax shelter over your head is still likely to prove a long-term winner.

2013 Tax Numbers Announced, Plus 2013 Tax Planning Advice

A variety of numbers that are important for 2013 tax planning were recently released by the Internal Revenue Service and Social Security Administration.

First, let’s talk retirement accounts. In 2013, maximum 401(k) contributions from your own paycheck will be capped at $17,500 for the year, an increase of $500 over 2012. For folks 50 and older, the “catch-up” limit remains the same, at $5,500. Personal IRA contributions will be limited to $5,500 for those under 50, and $6,500 for those age 50 and older. For SIMPLE accounts, the maximum contribution increases to $12,000, with a $2,500 catch-up limit for those 50 and over.

While elimination of the Social Security taxable wage limit is one of the proposals on the table in Washington, D.C., the inflation adjusted cap for 2013 is currently slated to be $113,700, up from $110,100 for 2012. This is the maximum salary level per year per person on which Social Security taxes are charged. Your wages above that amount are not subject to that particular tax. Expect this to be a hotly debated item during the next Congressional session.

Also on the Social Security front, retirees that have not yet reached full retirement age for their birthdate can earn up to $15,120 in 2013 from employment without losing any Social Security benefits.

If you provide cash gifts to others, you’re in luck in 2013: The annual gift tax exclusion has increased to $14,000 for 2013. Do note, however, that this is als a hotly contested item, and may be on the retroactive chopping block for 2013.

Lastly, Health Savings Account (HSA) contribution limits will increase to $3,250 for individuals and $6,450 for families next year.

In case you didn’t notice, the makeup of Congress and the White House had zero significant change in this year’s election. The Obama Administration may see some slight personnel changes, but control of the House remains with the GOP and the Senate with the Democrats, with only a few new faces coming in. Neither party, in neither house, saw a significant turnover in elected representatives as many had predicted.

Given this, and the pending fiscal cliff, I am advising clients to take full advantage of every tax break they can for 2012. Sometimes, it is best to defer certain taxable actions until the following year. However, given the likely continued gridlock in Washington, I personally predict that 2013 will be a very bad year in regards to tax deductions and tax credits that many take for granted.

If you have capital gains items that you can lock in your profits on now, and pay the current reduced tax rate on, I would encourage you to take your profits now and pay the tax in 2012. Similarly, if you have been considering deferring compensation, I would generally advise against it, as the Obama Administration and Senate Democrats are serious about pushing through higher marginal tax rates. I would also encourage you to take any green energy tax credits and education tax breaks that you can in 2012, as they probably won’t exist in 2013.

Looking into the magic 8-ball, I also anticipate reduced limits on charitable contributions and the home mortgage interest deduction. In fact, many Congress-critters want to eliminate the home mortgage interest deduction entirely, or at least implement a drastic phaseout. You should also be prepared for greater Alternative Minimum Tax (AMT) hits, even for those earning less than $75,000 per year. Also be ready for a higher AGI threshold for deducting medical expenses, and look for little things like the $250 deduction for teachers spending their own money on classroom supplies to go away.

In my opinion, 2013 is set to be one of the most “interesting” years in the field of U.S. tax regulation since 1986, when the entire tax code received a major overhaul. While I say “interesting” as a tax practitioner from an academic standpoint, that can be translated to “very, very bad” for most middle and upper income taxpayers. I expect that anybody earning more than about $35k or $40k per year will feel the effects of 2013 tax law changes directly in the wallet, despite political rhetoric to the contrary.

And just for the record, I would be writing these exact same words even if Romney had been elected and the GOP had taken control of the Senate. I belong to no political party, and support none. The current U.S. national debt is over $16 trillion, and increased by $1.1 trillion in FY 2011-12. In the first full month of FY 2012-13, which was the month of October, the Federal government already had to go another $200 billion in the hole.

Currently, mandatory spending (which includes interest payments on the debt and legally obligated entitlement programs), accounts for more monthly and annual spending than the U.S. government takes in. In other words, all Federal discretionary spending (which includes defense, education, etc.) is all on borrowed money. The only way to fix the problem is to take in more tax revenue and legislatively change the underlying laws that dictate mandatory spending.

Therefore, it is a mathematical impossibility for any administration, no matter which party is in charge, to both cut taxes and balance the budget. It’s very basic arithmetic, it simply can’t happen. To get anywhere near close to a balanced budget, social programs will require deep cuts in benefits, tax rates must increase, and tax credits and deductions must go away. All three of these moves basically require political suicide on the part of all Federal branches, in both parties.

Therefore, it’s not going to happen, and I anticipate that the next two years until the next Congressional election cycle will simply yield more gridlock, increasing debts, occasional Federal government shutdowns, continued quantitative easing (printing of money by the Treasury, which decreases the value of the dollar), more mudslinging and blame, and everything else we’ve been seeing for the last two years.

Unfortunately, that means many tax breaks will go away — and all of us will have to pay the price. Expect your tax burden to increase in 2013, simply by Congress NOT acting, and plan accordingly.

5 Simple Steps To Achieving Mitt Romney’s Tax Rate

Republican presidential candidate Mitt Romney has been getting blasted for months about the fact this effective tax rate is so incredibly low. As an Enrolled Agent, I find the discussion surrounding Romney’s tax situation to be particularly interesting, because there isn’t a single taxpayer on the face of the Earth that personally wants to pay more taxes than they have to. If such a strange person does exist, there is no government that won’t happily cash your check (in fact, the U.S. government happily accepts credit cards for donations).

I’d really like to get on the phone with all these reporters and news anchors blasting Romney for his tax reduction strategies. I’d bet $100 that you can’t find one that would, themselves, personally agree to pay more taxes than they need to. Yet, they will happily ridicule somebody else for doing so.

Actually, I need to back up, because there is actually one person I know of that voluntarily pays more taxes than he’s required to. Guess who that is? Mitt Romney.

That’s right. In order to keep a campaign promise earlier this year stating that he has paid at least 13% in taxes each of the past 10 years, Mitt Romney voluntarily failed to claim $1.75 million in charitable contributions on his 2011 Form 1040. In other words, he only deducted $2.25 million of the total $4 million he actually donated to non-profits. If he had claimed the full deduction, his 2011 effective tax rate would only have been 12%.

Mitt Romney’s strategy for only paying an effective tax rate in the low teens is perfectly legal.

The Internal Revenue Code requires every American citizen, at home or abroad, to pay taxes on all income, from whatever source derived, whether that money is made in America, or overseas. The law requires everybody to pay their mandatory tax amount, and not a single penny more. The tax laws are the tax laws, and the law is the same for every citizen. Just because you are rich does not magically change the tax laws (just ask Wesley Snipes, serving three years for tax fraud).

Some people complain that the tax code favors the wealthy. This simply isn’t true. The tax code provides equal opportunity for all. Equal opportunity to minimize, but also equal opportunity to get screwed.

What does this mean, and and how can you take advantage of it?

First of all, realize that Congress typically makes thousands of changes to the Federal tax code each and every year. Just about every bill passed has some minor tweak to the tax code associated with it.

Second, understand that the tax code is used by the government as a tool for social engineering and economic stimulus. This isn’t a secret — it’s a well documented fact. Certain elements of the tax code exist for the sole purpose of wealth redistribution, such as the Child Tax Credit and Earned Income Credit, both of which are social welfare programs that the government simply chose to implement via the income tax system. Other elements of the tax code exist in order to encourage small business investment, such as tax credits for research and development and domestic production activities. Other pieces of the tax code are intended to attempt to create jobs, such as payroll tax credits for hiring veterans or displaced workers.

The secret behind Mitt Romney paying such a low effective tax rate has to do with his income sources. As I write this, I’m looking at Romney’s 2011 Form 1040, page 1. This return lists the following major income sources and amounts:

  • $4.1 million in taxable interest
  • $3.2 million in taxable dividends
  • $10.8 million in capital gains
  • $2.8 million partnership and trust income

Romney’s tax on all this income isn’t figured using the regular tax tables, and not just because the numbers don’t go that high. Currently, his interest and partnership/trust income is taxed at normal income tax rates, but the $14 million in dividends and capital gains are taxed at much lower rates, currently only 15%.

That 15% tax rate is scheduled to expire at the end of 2012, as part of the expiring Bush tax cuts. However, the U.S. has a long history of creating special reduced tax rates for dividends, capital gains, and other forms of investment income, and there is a perfectly valid reason for doing so: Investment income derives from putting your money to work within the company, which generally creates jobs.

Economic investment has long been the primary source of jobs within modern economies. Without investment, most economies would grind to a screeching halt (been to Greece lately?). In order to encourage people with money to put that money to work within the economy, rather than just saving it under a mattress, governments offer incentives for investment. One such incentive is a reduced tax rate on the investment earnings. Those investments stimulate the economy, create jobs, and keep the economic engine churning for the rest of us. It’s a very critical component of keeping a modern economy operating.

When I flip to page 2 of Romney’s 1040, I see $5.7 million in itemized deductions. Looking at his Schedule A, I can see $4 million in charitable donations alone, of which he only claimed $2.25 million. He paid $2.6 million in tithing to his church. He also deducted $1.5 million in state and local taxes he paid.

Romney could have claimed the entire $4 million in charitable donations. I also see that he claimed absolutely zero business expenses on his Schedule C, and thus paid income tax and self-employment taxes both on every dime of speaking fees he collected.

I’m not going to review every line of this 104 page tax return. What becomes readily apparent, however, is that a tax minimization strategy is possible for everybody, no matter how much or how little your income. I’ll recap the “Mitt Tax Reduction Strategy” in a short list of steps, in case you didn’t pick them up through the course of this article:

Step 1: Own and operate your own small business.
Step 2: Invest in dividend-generating securities.
Step 3: Invest in activities that will produce capital gains.
Step 4: Invest in tax-free investments, such as municipal bonds.
Step 5: Donate a large percentage of your income to non-profit organizations.

Not only does this strategy work for rich people, it works for working class stiffs like us, also. If you’re self-employed, you get to write off an amazing array of things that people that work for other companies can’t, including deductions for business use of your home and your vehicle. Everybody can invest in securities that provide tax-free interest income, generate dividends, and produce capital gains. And everybody can donate to their favorite worthy causes.

Even people earning $30,000 per year can make this sort of thing happen: I’ve not only seen it with clients, I’ve done in myself.

No matter how much or how little money you make, the tax code can either work for you, or against you – the choice is really up to you. Prudent investment management, careful personal financial management, and proactive tax planning can all work together together to drastically reduce your effective tax rate, also.

To schedule a tax planning appointment, feel free to contact me.