Richard A. Lindsey, CPA

Lindsey & Waldo, LLC – Certified Public Accountants

  • May 12

    I’ve written before about what a good tax planning technique hiring your children can be. (See “Hiring Your Children for the Summer: The Job of Last Resort or Just Good Tax Planning,” Taxing Times, June 2015.) It can be an effective way of shifting income from your high rate to as low as zero percent! It can also be good for the kids. However, as a recent tax court decision demonstrates, it’s important to dot your i’s and cross your t’s.

    The case involved Lisa Fisher, a New York attorney, faced with a common dilemma to find summer care for her children, all under the age of nine. So, during the summer, she brought them into her office two or three days a week where they shredded waste, mailed letters, answered phones, greeted clients, and copied documents.

    Fisher took deductions for the $28,770 in wages she paid her kids over a three year period. But, she didn’t keep any payroll files or issue any W-2s. She didn’t keep any records substantiating the work they did or establishing that she paid “reasonable compensation” for the work performed. Nor could she present any documentary evidence, such as cancelled checks or bank statements, to verify that she actually paid them the wages she deducted.

    You know where this is headed. The IRS disallowed the deductions for the children’s wages and imposed an accuracy related penalty. The Tax Court affirmed that decision.

    Bottom line: Hiring your children to work for your business, or rental properties, can be perfectly legal tax planning. But, you have to follow the rules and document everything in order to protect the benefits.

  • Oct 28

    In what may come as a shock to many of you, the country is broke and is looking for additional revenues. You should know, it will be looking in every nook and cranny to replenish the federal coffers. What you may not know is the Internal Revenue Service seems already to be engaged in revenue-finding-missions. Among the objects of their affection – in the tax audit – are sole proprietors filing Schedule C, and substantiation requirements for every possible deduction.

    The IRS now views the Schedule C as the repository of all manner of evil taxpayer intentions to reduce their tax liabilities (and, from the perspective of the IRS, federal revenues). IRS agents are reportedly beating the bushes of sole proprietors primarily to reduce, or eliminate, claimed deductions as unsubstantiated to increase both income and self-employment tax liabilities.

    All deductions are a matter of legislative grace, and that grace comes with a price: at a minimum to maintain books and records to support the expenditure, and, in many cases, to meet more exacting substantiation standards than the Code imposes as a condition to deductibility in various circumstances. One might not think of charitable contributions as a source of major contention with the IRS, but in the case of non-cash contributions, the taxpayer is technically required to establish, both the fair market value of the property and the property’s adjusted basis. In some cases, the Code requires an appraisal of property (where the value exceeds $5,000) contributed to a charity.

    However, the property’s adjusted basis comes into question in two cases: first in most cases where the property is inventory in the hands of the donor, and secondly, if tangible personal property that is unrelated to the charity’s exempt function, the amount of the contribution is limited to the donor’s adjusted basis in the property. For example, if a taxpayer donates used clothing to a charity that does not distribute them to poor or indigent individuals, the deduction is limited to the lesser of your basis or fair market value. Now, it may seem like common sense that the current value of almost all used clothing is less than what was paid for it but technically, a claim for a deduction of such items requires some proof of both the fair market value and the cost basis of the property.

    And such was the case I recently read about in Surgent’s Tax Issues Newsletter where a taxpayer was denied a claimed $850 deduction for clothing donated to charity. Yes $850! The return was under audit and the taxpayer submitted photographs of all the clothing donated and matched them up to the current list of retail prices published by The Salvation Army and recognized by the IRS– but that wasn’t enough. The auditor wanted purchase receipts of each item to establish the cost basis. Even if the taxpayer was in the 35 percent tax bracket, the amount of tax at issue was only $298. The IRS correctly assumed the taxpayer would throw in the towel rather than incur additional time, effort and costs to substantiate the deduction. So, the IRS pressed the issue hard enough to deny any deduction. Hooray, the deficit was reduced $300!

    From a practical standpoint, trying to establish the cost of most any item of personal property even shortly after its purchase, much less a couple of years down the road, is extremely difficult. So, nothing prevents the IRS from using similar audit strategies where larger sums of money are involved.

    Echoing the motivation Willie Sutton once famously gave for robbing banks, the Internal Revenue Service knows where the money is.

  • Feb 19

    Like Bama’s win over Clemson – you expected it to happen, but they waited until the last minute to make it happen – Congress has once again extended the “extenders”- a varied assortment of more than 50 individual and business tax deductions, tax credits, and other tax saving laws which have been on the books for years, but which technically are temporary because they have a specific end date. This package of tax breaks has repeatedly been temporarily extended for short periods of time (e.g., one or two years), which is why they are referred to as “extenders.”

    Most of the tax breaks expired at the end of 2014. Now, in legislation passed just before the Congressional Christmas break, the extenders have been revived and extended once again, but this time Congress has taken a new tack. Instead of just rolling the package of provisions over for a year or two, it actually made some of the provisions permanent and extended the remaining provisions for either two or five years, while making significant modifications to several of the provisions.

    Key tax breaks for individuals that were made permanent by the new law include:

    • Tax credits for low to middle income earners that were originally enacted as part of the 2009 stimulus package and were slated to expire at the end of 2017: (1) the American Opportunity Tax Credit, which provides up to $2,500 in partially refundable tax credits for post secondary education, (2) eased rules for qualifying for the refundable child credit, and (3) various earned income tax credit (EITC) changes;
    • the $250 above-the-line deduction for teachers and other school professionals for expenses paid or incurred for books, certain supplies, equipment, and supplementary material used by the educator in the classroom; also modified, beginning in 2016, to index the $250 to inflation and include professional development expenses;
    • parity for the exclusions for employer-provided mass transit and parking benefits;
    • the option to take an itemized deduction for state and local general sales taxes instead of the itemized deduction permitted for state and local income taxes;
    • increased contribution limits and carry forward period for contributions of appreciated real property (including partial interests in real property) for conservation purposes; the new law also extends the enhanced deduction for certain farmers and ranchers; and,
    • the provision that permits tax-free distributions to charity from an individual retirement account (IRA) of up to $100,000 per taxpayer per tax year, by taxpayers age 70 ½ or older.

    Key tax breaks for individuals that were extended by the new law include:

    • the exclusion of up to $2 million ($1 million if married filing separately) of discharged principal residence indebtedness from gross income; extended through 2016; the new law also modifies the exclusion to apply to qualified principal residence indebtedness that is discharged in 2017, if the discharge is pursuant to a binding written agreement entered into in 2016;
    • the credit for energy-efficient improvements to principal residence extended through 2016;
    • the deduction for mortgage insurance premiums deductible as qualified residence interest; extended through 2016; and
    • the $4,000 above the line deduction for qualified tuition and related expenses; extended through 2016.

    Key tax breaks affecting businesses that were extended by the new law include:

    • The Work Opportunity Tax Credit was extended through 2019; the new law also modifies the credit beginning in 2016 to apply to employers who hire qualified long-term unemployed individuals (i.e., those who have been unemployed for 27 weeks or more) and increases the credit with respect to such long-term unemployed individuals to 50% of the first $6,000 of wages;
    • 15 year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements were made permanent;
    • 50% bonus depreciation was extended for property placed in service during 2015 through 2019; the 50% rate is phased down to 40% for property placed in service during 2018 and 30% for property placed in service during 2019;
    • previously increased first-year depreciation cap on trucks and vans not weighing over 6,000 lbs. has been extended through 2017; the increased first year depreciation is lowered for 2018 and 2019 and disappears in 2020; and
    • increase in Section 179 elective business expensing (up to $500,000 annual write-off of eligible business property costs that is phased out as those cost exceed $2 million for the year) is made permanent; also made permanent is the allowance of expensing for computer software and qualified real property.

    Caution: This article contains a general overview of selected tax provisions contained in the PATH Act and does not address all tax provisions contained in the Act. Tax law is constantly changing due to new legislation, cases, regulations, and IRS rulings. Please contact us if you’re interested in a tax topic that is not discussed in this article.

  • Feb 5

    Have you ever thought: “What should I do if my 1099 is wrong?” Well, here are four steps to take if you are issued an incorrect Form 1099.

    1. Contact the issuer as soon as possible. Once you contact the issuer, explain to them that the 1099 was issued for the wrong amount. You should be able to prove to the issuer the correct amount that should have been reported. Then, ask the issuer to reissue the 1099 with the correct amount. Hopefully you can catch the issuer before they file the 1099s with the IRS. If so, the issuer can easily reissue the 1099 with no problem.
    2. Another great item to get as proof is a letter from the issuing company that states the original 1099 was issued in error, the original 1099 has been destroyed, and a new, corrected 1099, in the stated corrected amount, has been issued. This letter of proof could come in handy if the company did not take the proper steps in correcting the 1099 with the IRS.
    3. If the company has already issued your 1099 and sent it to the IRS, the company will need to issue a “corrected” 1099. The box on the top of the 1099 should be marked as “corrected.” If the original 1099 was previously sent to the IRS, make sure the “corrected” box is checked on your new 1099. If it is not marked “corrected,” the IRS will think you were issued two 1099s from the same company and add them together.
    4. What happens if the company will not correct the original erroneous 1099? You will need to address this on your return. You will need to report the amount reported on the 1099 you received on your return, and then explain the overstatement of the 1099 in a footnote or statement.

    Most importantly always pay attention when you receive a 1099 to make sure you were issued a correct 1099. It is easier to address the issue of an erroneous 1099 earlier than later.

  • Oct 15

    It didn’t take long for her business to fold.

    She was 22 years old, passionate, excited and a first time business owner.

    Why was she forced to close the doors?

    Not the reason you might expect: lack of sales.

    She went out of business because she didn’t keep good records. Records for taxes, budgeting, and cash flow.

    Depending on your personal experience, it may or may not surprise you that poor recordkeeping is one of the top reasons for business failure.

    Taking care of billing, tracking your expenses, taxes, and other financial housekeeping can seem overwhelming, stressful, or just plain boring for new business owners.

    Even for those who’ve been in business a while it is often one of their least favorite things to do. So it’s easy to coast along thinking everything is hunky dory – that’s a technical term – until WHAM! All of a sudden you discover sales are down by 20 percent and expenses are up by 15.

    Getting and keeping your financial house in order makes things not only less stressful, but can help ensure that you don’t overspend and that you have enough money for your savings, investments and retirement.

    Here are five tips for getting your financial house in order.

     

    1. Get some advice. I know, I know, it sounds self serving but, if you’ve never been in business for yourself, or if you struggle with managing your finances, get some advice. It could be the smartest investment you make in your business, and one that could prove crucial to your survival.
    2. Create a budget. Yes, I know it’s not exciting or sexy. You want to get out there and sell, do, or make whatever you started your business to do. But, IT IS NECESSARY! Be very conservative. Plan for the worst case scenario, not the best.
    3. Track everything. Keeping track of income, expenses, invoices, past due customers, estimated taxes, payroll, etc. can feel daunting at times; however, not doing it can lead to financial ruin or legal hot water. There are plenty of financial tools out there. The QuickBooks you’re already using can be used as a dashboard if you keep it up to date.
    4. Put aside money with every deposit. Put aside a portion of every deposit you make for savings, taxes, and charitable contributions. There are more reasons than I have room to address for why you should save for a rainy day. Included are some real psychological benefits for doing so.
    5. Plan for your retirement. When you are a small business owner, there is no one else to fund your retirement. Even if you’re 22 years old and passionate when you start, that’s not necessarily going to provide you retirement funds when you’re 72. Setting up a retirement plan can also shelter some of your business profits. Start with an IRA then graduate to a SIMPLE plan or Keogh.

     

    Integrate these tips into your business and you’ll find it easier to get and keep your financial house in order; therefore making your business less stressful.

  • Jul 10

    Many business taxpayers overlook legitimate business deductions, resulting in an overstatement of their tax liability. Some of the more commonly missed deductions include business expenses paid out of personal funds, expenses related to a home office, and the use of personal telecommunication devices for business purposes.

    General Business Expenses
    Generally, a deduction is allowed for all ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. Business owners who use their personal funds for business expenses, such as office supplies, often fail to deduct this as a qualifying expense.

    A trade or business expense is deductible as such only if it is “ordinary and necessary.” An “ordinary” expense is generally one that is normal, customary, or usual for a business under the facts and circumstances of the situation. A “necessary” expense is one that is appropriate and helpful for the trade or business. A final requirement is that this expense must be reasonable.

    One of the more commonly overlooked general business expenses is the business use of personal telephones, cellular telephones, and Internet connections. If you carefully document how much these devices are used for personal and business use, the business portion may be deductible.

    Home Office Deductions
    If you use part of your home as a home office, you may be entitled to deduct expenses related to your home office based on the square footage the home-office occupies. Related expenses include mortgage interest, property taxes, utilities, insurance, and repairs.

    To qualify for the deduction, the portion of the home that is used for the home office must be used regularly and exclusively as your principal place of business. To be your principal place of business your home office should be the place where, in the normal course of business, you meet with patients, clients, or customers.

    Meals and Entertainment Expenses
    Business owners will frequently use their personal funds to pay for meals and entertainment expenses. These expenses qualify as a business deduction, subject to certain limitations. To be deductible as business expenses, entertainment expenses must have a proximate relation to your trade or business and be reasonably expected to benefit the trade or business.

    Deductions for business meal expenses are subject to the same business connection requirements as entertainment expenses. However, the deduction will be denied if the meals are lavish or extravagant or if you or an employee are not present when the food or beverage is served. The deduction is allowable when the customer’s spouse, your spouse or both are present at the meals, provided the general conditions for deductibility are otherwise present. The cost of entertaining business associates and customers at home is also deductible. However, in the case of business meal entertaining at home, you must be able to clearly show that the expenditure was commercially rather than socially motivated.

    Substantiation
    Regardless of the type of cost you are trying to deduct as a business expense, you must be able to substantiate each expense and how it relates to your trade or business. The importance of keeping accurate and appropriate records cannot be over emphasized.

  • Jun 5

    Bryan Martin had always dreamed of owning his own business, but, according to a Time.com article, it wasn’t until insurance giant Zurich shuttered their regional Indianapolis office where he worked that he decided to strike out on his own.

    “It’s the scariest thing I’ve ever done,” the article quoted Martin, who had just turned 51 and has a wife and 13-year old twins. “Right now, I’m just worried about financially making all this work.”

    Are you out there with Martin? Has the rising unemployment rate sent you into the entrepreneur minefield? Are you crawling along like a soldier, poking the ground with a stick, trying to find, identify, and avoid the tax mines just to pay your mortgage and put food on the table? A growing number of the nation’s jobless are doing just that.

    But as the ranks of brand new entrepreneurs swells so is the likelihood of errors and even, dare I say it—IRS audits! The IRS audits individual returns with Schedule C income at twice the rate of those without. Since the IRS’ Tax Gap analysis identifies underreporting of business income as a $109 billion problem, accounting for more than half of the total underreporting by individuals, the chances of those audits increasing are pretty good.

    Many new entrepreneurs, strapped for cash, try to cut corners and make the rookie mistake of forgoing the use of accountants and attorneys and picking up TurboTax® to handle their taxes on their own.

    The Internal Revenue Code is fraught with obstacles and the wide-eyed rookie is unlikely to recognize the danger signs. “My neighbor told me I could do this,” won’t stand up against the glare of an IRS examiner. Many budding business owners hear about the generous tax benefits for business expenses from travel and entertainment to the holy grail of tax deductions, the home office. But most have no clue what is allowed and what will send up a red flag. There are many misconceptions about the tax laws and the wrong decision can turn dreams into nightmares.

    The sheer magnitude of available tax breaks causes problems for many rookies. When you’re a self-employed small business owner, nearly everything looks like it should be deductible. After all, many feel they don’t do anything that isn’t business related.

    But the pearly-gate vision of deducting everything leads many an entrepreneur to forget the rules of mine clearing and wander off course into profit-bleeding blunders. Some of the most common mistakes include poor record-keeping, questionable tax deductions, putting expenses on the wrong tax form or line and failing to pay quarterly estimates to Uncle Sam.

    It’s critical that businesses maintain books, records, separate bank accounts and credit cards from their owners. In the event of an audit, people often lose, not because they were trying to get by with something, but because of poor records. When a taxpayer can’t produce records to match the tax return, the auditor smells blood. They have spotted a weakened wildebeest separated from the herd and they are going in for the kill.

    Make no mistake, it will be painful.

    But it doesn’t have to happen. With the proper records and the right advisor you can successfully chart a course across the tax minefield and come out unscathed.

    If you’ve entered the minefield, or are thinking of entering it, remember, our experience can help you identify the obstacles, spot the dangers and chart a successful crossing.

  • Apr 30

    Do you have unexpected areas of overspending in your small business?

    First of all: Why would any expense be unexpected? I mean, as a small business owner, are you sure you’re getting accurate financial statements every month? Do you understand what those statements say, or did you just use the closest QuickBooks chart of accounts template? I don’t mean to be harsh, but if you’re overspending, it’s a sign that you’re not on top of your game.

    That said: there are two key areas in almost any business where overlooked costs can spiral out of control. What’s sinister about them is that they may appear benign on your income statement—just the cost of doing business. It’s not until you compare the numbers against last quarter or last year that red flags pop up.

    Nearly every business sells something or provides a service to customers/clients/patients (or both). The direct costs associated with this activity should be recorded in the cost of goods sold or cost of services provided section of your income statement. However, I find that with many small businesses it’s quite common for these costs to end up under operating expenses, where it is easily overlooked.

    When I started working with a securities systems company, all the payroll costs were lumped together under operating expenses. Because it was easier. But in reality, he had no idea how much his payroll was affecting his profitability and his long-term success. Unless all these direct costs are correctly split out into the appropriate categories, there is no way to accurately calculate the gross margin on your products or services. At worst, you could be in for a nasty surprise— you could actually be losing money on each sale or job.

    If this seems simple, it is. I can tell you from experience that many entrepreneurs inadvertently overspend in the cost of goods category in the name of growth.

    Businesses have a laundry list of insurance coverages: workers’ compensation, unemployment, general liability, general property and casualty, vehicle, health and other employee benefits. It’s a lot of paperwork and a lot of hassle—so much so that many entrepreneurs are reluctant to change their routines, despite high costs.

    When was the last time you shopped around for insurance plans? I’m not referring to the options your insurance agent/broker presents to you; rather, to shopping among several agents/brokers to see who comes up with the best deal for your business.

    While you’re at it, ask each candidate to evaluate your current program for limits that are too high or too low and for areas in which coverage may be lacking entirely. Experts tell me, if it’s been a few years since you went through this process, you should be able to save at least 20% on your insurance premiums.

  • Feb 20

    Whenever you fix or replace something in your business or rental property you have to determine, for tax purposes, whether you have made a repair or an improvement. What difference does it make? Because you can deduct the cost of a repair, but you must capitalize the cost of an improvement and recover that cost through depreciation. On your commercial building or rental property that could be as many as 39 years.

    For example, if you classify a $1,000 expenditure as a repair, you get to deduct the entire $1,000 in the year you spend it. If you classify the expenditure as an improvement, you’ll likely have to depreciate it over 39 years and the most you’ll get to deduct in depreciation this year is $25.

    HUGE Difference!

    The difference between a repair and an improvement has, historically, been difficult to determine. Often we relied on various subjective interpretations and court cases for guidance. In an effort to clarify matters, the IRS has issued over 200 pages of complex regulations explaining how to tell the difference.

    With the final regulations, the IRS has provided rules for classifying property as deductible materials and supplies and provided guidance for identifying (generally capitalized) costs of acquiring tangible real and personal property. A key area addresses what is a unit of property versus a component, with implications for determining depreciable class life.

    A capitalized improvement to property is also now more precisely defined, mainly as expenditures that result in a betterment, adapt the property to a new or different use, or restore it to working order or like-new condition after the end of its depreciation class life (the BAR tests).

    The IRS estimates the new regulations will affect about 4 million businesses. Every affected business will need to elect new treatment for 2014 that may require an application for an accounting method change.

    Significant provisions of the new regulations include:

    Materials and supplies. The threshold for deduction materials and supplies was increased from $100 to $200 and generally applies to items expected to be consumed in 12 months or less, or that have an economically useful life of 12 months or less.

    De minimis safe harbor. The new regulations allow a taxpayer with an “applicable financial statement” to deduct up to $5,000 of the cost of an item of property per invoice (or per item substantiated by an invoice). Taxpayers must have a written policy in place at the beginning of the tax year that specifies a per-item dollar amount (up to the ceiling) that will be expensed for financial accounting purposes. Taxpayers without an “applicable financial statement” may expense up to $500 per invoice/item.

    Example: David purchased an Orange Beach condo through his limited liability company (LLC) to add to his rental portfolio in November 2013. However, the condo came sans appliances, and in February 2014 David purchased a refrigerator for $499, a washer for $459 and a dryer for $479. They were all delivered the same day and the invoice totaled $1,437. If David elects to take advantage of the de minimis safe harbor, he must expense the appliances since they are each individually under the $500 threshold.

    Unit of property. The general rule for determining a unit of property other than a building provides that all of the components of a property that are “functionally interdependent” comprise a “single unit of property” (UOP). The regulations say: “Components of property are functionally interdependent, if the placing in service of one component by the taxpayer is dependent on the placing in service of the other component by the taxpayer.”

    Example: John purchases a new automobile for his business. John cannot place the automobile into service without tires; therefore, the automobile and the tires may be a unit of property.

    Routine maintenance and improvements. The new regulations contain controversial “unit of property” rules that apply the rules for real property to eight separate building systems. However, the rules do extend the routine maintenance safe harbor to real property and provide a new safe harbor for small taxpayers. The real property safe harbor for small taxpayers allows expensing of amounts paid for repairs, maintenance and improvements when the total costs during the year do not exceed $10,000 or two percent of the unadjusted basis of the building.

    Example: Jack owns an office building with ten roof-mounted heating/air conditioning units. In June 2014, two of the units began malfunctioning and the tenants complained. Jack replaced the two malfunctioning units with new units that are 10% more energy efficient than the old units. No work is performed on the other roof-mounted heating/cooling units.  Jack can deduct the cost of the two new units as repairs because the “unit of property” is the HVAC system and replacing two of the ten units with similar units is not a betterment or improvement.

  • Jan 9

    The 2015 optional standard mileage rates used to calculate the deductible cost of operating an automobile for business, charitable, medical or moving purposes has been released by the Internal Revenue Service.

    Beginning on January 1, 2015, the standard mileage rates for the use of a car, van, pickup or panel truck will be:

    • 57.5 cents per mile for business miles driven, up from 56 cents in 2014,
    • 23 cents per mile driven for medical or moving purposes, down half a cent from 2014
    • 14 cents per mile driven in service of charitable organizations.

    The standard mileage rate for business is based on an annual study of the fixed and variable costs of operating an automobile, including depreciation, insurance, repairs, tires, maintenance, gas and oil. The rate for medical and moving purposes is based on the variable costs, such as gas and oil. The charitable rate is set by law.

    Taxpayers always have the option of claiming deductions based on the actual costs of using a vehicle rather than the standard mileage rates.