Okay, so you owe money to the IRS and haven’t paid yet. You get a notice in the mail saying that the IRS has slapped a lien on you (the lovely form 668(Y) Notice of Federal Tax Lien). So what exactly does that mean?
A lien means that the IRS is claiming first dibs on your money if you sell something—like a house or a car. A lien is a legal document that goes through the courts. Your creditors; the mortgage company or the bank holding your car loan are publicly notified that you owe the IRS money.
Let’s say you owe the IRS $20,000 and the IRS places a lien for your tax debt and you sell your home. The IRS is in line to get its money before you get any of the profit.
The lien also goes on your credit report. If you’re trying to buy a new home or even get a credit card, the IRS lien may prevent you from obtaining credit.
How bad does your tax debt have to be before the IRS files a lien? It used to be that the IRS would file a lien once you owed over $5,000, but starting in February of 2011, they raised it to $10,000. If the IRS issued a lien on you under the old rules, they won’t withdraw it just because of the rule change.
So how do I get the IRS to withdraw a lien? Well, paying the tax is the most effective way to remove a lien.
What if I don’t have enough money to pay the tax? That’s harder, but not impossible. You’ll need to be in a payment agreement, but not just any payment agreement—you’ll have to have a “Direct Debit Installment Agreement” if you want to have the lien removed. Direct debit is where you give the IRS permission to take the money directly out of your checking account every month (as opposed to mailing them a check or you paying them online.)
If you want your lien removed, you’ll also have to meet some other eligibility requirements.
· First, the amount you owe must be $25,000 or less. If you owe more than that, you can’t apply to have your lien withdrawn until you’ve paid the debt down to that amount.
· Also, your Direct Debit Installment Agreement monthly amount must be large enough that you can pay off the full amount of your tax debt within 5 years. For example, if you owe $20,000, you’d take the $20,000 and divide by 60 months. You wouldn’t be able to release your lien for less than $334 per month.
· Don’t apply for a lien release until you’ve made at least three consecutive direct debit payments.
· You can’t have already gotten a lien withdrawal for the same taxes, meaning that if you filed for a withdrawal before and then screwed up later, you’re not getting it withdrawn this time.
· Also, you can’t have defaulted on your current, or any previous, direct debit installment agreement.
Okay, so I’ve done everything necessary, how do I get the lien withdrawn? You’ll need to file another form of course! It’s called form 12277, Application for Withdrawal of Filed Form 668(Y), Notice of Federal Tax Lien. Is that a mouthful or what? The name of the form is longer than completing the form itself. Most of the questions are easy, like your name and social security number. The only question that you need help with is number 8: what reason are you requesting the withdrawal for? You want to check box “b.” You entered into an installment agreement. That’s it. Here’s a link to the form: http://www.irs.gov/pub/irs-pdf/f12277.pdf
What if I can’t do all of this stuff? Then you live with the lien until things change. It’s a lien, not a levy. They haven’t garnished your wages, they haven’t grabbed your bank account. Now if you don’t shape up and get your taxes taken care of, that could happen in the future, but not if you stay on top of things and actively work with the IRS to get your debt taken care of.
Don’t play ostrich and bury your head in the sand. Trust me, the IRS won’t just go away. A lien isn’t good, but it’s not the end of the world. If your financial situation is that bad, perhaps you might be able to negotiate an offer in compromise or a reduced payment option. (This is a point where it might help to get professional assistance. Some people are perfectly comfortable with these negotiations, but most folks aren’t). The point is, you have to make the move to solve the problem. You must be in control (as best as you can). Generally, if you’re on top of things, the IRS will be much easier for you to work with.
It’s audit season and I just got back from meeting with the IRS. So far this season, I’ve worked with two different artists and they both were contacted about the same thing: Cost of Goods Sold.
If you go to the IRS website and research what they’re looking for, you’re not going to find much information. I did find an old IRS audit guideline for artists from back in the 90’s, but that didn’t address Cost of Goods Sold for artists either.
In a normal business, Cost of Goods Sold would be what you pay for the stuff you sell. For example: say you own a teddy bear store. You pay $5 for each bear and then you turn around and sell the bear for $10. You start the year with 100 bears in your inventory, you buy 500 more bears to sell, and you end the year with 50 bears in your inventory. Let’s do the math:
Beginning inventory: $500 (100 bears times $5 each)
Purchases: $2,500 (500 bears times $5 that you paid for each new bear)
Ending inventory: $ 250 (because you have 50 bears left times the $5)
Cost of Goods sold: $2,250 (this is the confusing one: you take the 500 and add the 2500—that’s all the bears that you’ve purchased to sell, right? That equals $3000. Then you subtract the ending inventory 250 (because you didn’t sell those) and you’re left with $2,250—that’s your Cost of Goods Sold.)
But if you’re an artist, you don’t have a bunch of identical $5 bears. How do you even begin to value your artwork? Here’s the thing—most artists should not be doing a Cost of Goods Sold report on their taxes. Let me repeat that: Most artists should NOT be doing a Cost of Goods Sold report on their taxes.
Think about your art. If each piece is a unique work, where the value of the piece is mostly due to your labor as opposed to the materials that you put into the work, then generally you’re fine just writing off your expenses as “expenses” rather than listing your materials as a Cost of Goods Sold.
So at what point do you “cross over” from just recording your expenses to actually keeping inventory? I asked that at the IRS the other day. “It’s really hard to say,” was the answer I got. Even for an IRS agent with years of experience, this was a tough question. If you’re mass producing works-for example you’ve produced a limited edition of numbered prints, well then that’s a case where you should be taking inventory. Still—your purchases are only the products that you sell. For example: you pay $2,000 to have 100 prints produced which you then hand number and sign. You sell 70 of the prints for $100 each.
Your Beginning inventory: $0 (up until now, all of your art was unique. You never did COGS before)
Purchases: $2000 (because that’s what you paid for them)
Ending inventory: $600 (You have 30 prints left and they cost you $20 each because 2000 divided by 100 equals 20.)
Cost of Goods Sold: $1400 (You started with $0, you added $2000 in purchases. To get the Cost of Goods Sold you subtract the ending inventory of $600 and you get $1400.)
Is this making sense? Art and Accounting don’t go together well, but you need to know this stuff. (And I’ve worked with enough artists by now to know that you’re way better at math than you let on.)
But what about the 70 prints I sold for $100 each? That goes in the front of your schedule C, $7000 under gross receipts on line 1.
Cost of Goods Sold will go on line 4.
You’ll take your Gross Receipts minus your Cost of Goods Sold to get your Gross Income. In this example, you’d take the $7,000 – $1,400 to get $5,600.
But once again, let me make this clear—as a professional artist, you shouldn’t be using Cost of Goods Sold unless you are producing a significant amount of work and you have a way of determining the cost and a way of counting the work. For example: A painter could count canvasses, but it would be almost impossible to count paint. Canvas could be a COGS but paint would be a regular expense. A potter might be able to count pounds of clay, but the tools and glazes might need to be a regular expense.
If you choose to count your inventory, it’s important to value items at what they cost and not what you are selling them for. Let’s go back to our example about the prints. You paid $20 apiece for them so your ending inventory of 30 prints is worth $600. If you value your inventory at what you want to sell the prints for ($100 apiece) then your ending inventory will be $3000—that’s more than you spent on the prints to begin with. If you did that on your tax return, your COGS would come out as negative $1000 and your income would go up to $8,000 instead of the $7000 that you actually made. Valuing your inventory at the “retail” price will really mess you up, so don’t do that.
Remember, as an artist your business situation is as unique as your art. Don’t let your packaged software intimidate you into using Cost of Goods Sold when you shouldn’t. If you’re thinking that you produce enough that you should be taking inventory, spend the money to get help from a professional so that you get started on the right track. It’s much cheaper than an audit.
If you’re an artist, you may have been asked to donate a piece of your artwork for a good cause. You might have also been told that it’s good PR for you, because people at the event will get a chance to see your work and bid on it. And of course you’ve been told that your donation is tax deductible.
While it’s true that your donation is deductible, it’s not nearly as deductible for you as it is for me. Come again? You heard me right—your art donation is not as deductible for you as it is for me. Let me give you an example: Let’s say you donate a painting that would normally sell for $500. If I bought that painting and donated it to a charity, I’d get to write off the full $500 on my tax return as a charitable deduction. If you donate that painting instead, you can only write off the cost of the materials that you used to create that painting—depending upon what materials you’re using, that’s maybe $50 to $100.
Additionally most artists are sole proprietors, their art income goes on a Schedule C on their regular 1040 tax return. Your charitable donation can’t be counted as a business expense, it must go on your Schedule A with your other personal itemized deductions. If you don’t already itemize your deductions on a Schedule A, that donated painting gives you no tax benefit whatsoever.
I’m not saying that you can never donate to charity, I like charities and I think they deserve donations. It’s just that when you donate your art, you’re not getting much bang for your buck. So what are your alternatives?
One thing is to pay to “advertise.” For example: I support a small, local ballet company. I used to just donate money to them, but now instead I purchase an ad in their performance program. They get the money they need and I get a business deduction for advertising. This is especially good for me. Before, being in the 25% tax bracket, my $100 donation was worth $25 off my taxes. Now, as a business expense, my $100 advertisement reduces my taxes by $40 ($25 from my regular tax plus an additional 15% for my self-employment taxes.) The advertising option gives you the best tax value on your donation because you can use it to offset your self-employment taxes.
Do be careful about the charity advertising though. I once did an ad thinking I was supporting a local organization, when really the money was going to an advertising agency. The organization got some money, but most of it went to the promotional company. I won’t make that mistake again.
Another option for you is to donate the profits from one of your art pieces. For example, let’s take that $500 painting; assume you paid $100 for your materials,that’s a $400 donation to the charity. Most likely, that’s a better donation than what the charity would gain if they auctioned one of your pieces off. If you’re in the 25% tax bracket, you still get a $100 reduction in your taxes. It won’t help with your self-employment tax, but you do get the good feeling of making a donation and your art work sells for its actual retail value instead of some discounted auction price (another disadvantage of donating your art for charity.)
There are many worthwhile causes out there that need and deserve your help. If providing a piece of your art work is how you want to help, by all means do it. Just remember, it’s not your best tax strategy.
Here’s an easy Father’s Day Quiz for Dads. 1. What’s your wife’s name? 2. What are your children’s names? I told you this was an easy quiz. Now here’s the next part: same questions, but what would the answers have been three years ago? Any changes? If your answers have changed over the past few years, here’s a tougher question for you; did you change your will? How about your 401(k)? Your insurance policy?
You see, it happens to everyone. Our families change, we have children, we get divorced, we get remarried, people die. If we don’t manually go in and adjust who the beneficiaries are on our bank accounts, retirement plans, and such, then the money that we’ve worked so hard to save and care for our families might go to the wrong people.
It happens all the time. A man dies, and accidentally leaves a million dollar life insurance policy to his ex-wife. Perhaps his IRA goes to his dead brother. Or maybe he’s left his entire estate to his three eldest children completely leaving the youngest out of the will because he forgot to change it when the baby was born. These are all true stories: the ex-wife had been divorced for five years, the dead brother had been gone for ten years, and the baby was twenty years old.
We all like to think that our family members would do the honorable thing. Think that all you want. But put your wishes in writing with the proper documents. Even if your family does have the best intentions, and the highest level of integrity, if you don’t take care of assigning your beneficiaries, your assets will be left for state law to divide.
Let’s say you have no problem with your state laws and you agree with how the state determines the way your assets will be split. Fine. Of course, it could take years for the state to decide how to split your assets once you’re dead and your family could starve to death waiting. Let’s say you die and there’s no determination as to who your beneficiaries are. Generally, it takes about a year to get your assets out of probate, but I once worked on a case that took three years. For those three years, you know who got paid? I got paid for doing the tax returns, the financial manager got paid for handling the money in the account and the lawyers got paid a bundle.
You know who else got paid? The IRS got paid because the income from the assets in the account got taxed at the highest rate because we couldn’t pass any money through to the family. The family got nothing until the estate was closed. All that money eaten away by lawyers, number crunchers, and the IRS– what a waste. Is that really the choice you’d make?
So here’s your Father’s Day to do list: check your life insurance policy, your retirement plans, your investment and bank accounts, and your will to make sure that you have the people you want to receive that money listed as your beneficiaries. If you don’t, then that’s the first call you need to make Monday morning.
Your family loves you, and they’ll probably show it Sunday morning by giving you a new tie or maybe breakfast in bed. Let me tell you, you’ll get no glory by walking into the kitchen and announcing that you’ve “changed the beneficiaries” in your 401(k) or rewritten your will. That’s okay, you’ll know you did the right thing and that’s good enough for you strong, silent, Dad types. Happy Father’s Day.
Rule Number 1: If you learn nothing else from this post, learn this: don’t believe everything you read on the internet. Even if you read it in this article, you should always get some sort of definite confirmation of what I am telling you. There’s a lot of misinformation out there and some of the stuff can get you into big trouble with the IRS.
There’s a lot of hype these days about incorporating or setting up your LLC in Delaware or Nevada because these states have favorable business climates. But, unless your business is located in Delaware of Nevada, it doesn’t make sense to file your organization documents in these states. For one thing, tax law and business law don’t always go hand in hand. Here in Missouri, as with most states, if you’re earning the money here, you’re paying the taxes here—no matter where you incorporated.
Bottom line, if you own a small business, your business organization documents should be filed in the state that you live in, your employees live in, your customers live in, your shareholders live in, and where your offices are located.
Hiding or disguising your identity is another thing that doesn’t make sense for the legitimate small business owner. When you own a small business, you want people to know who you are and what kind of business you’re in. By the way, let me introduce myself. I’m Jan Roberg, I do taxes. I also write these blog posts myself. I want you to know who I am because I want you to remember me when you need tax help. That’s my picture up in the corner.
This is supposed to be tax blog, not a marketing blog, but seriously, if you own a small business—you want your clients and customers to know who you are, what you do, and how to find you. (By the way, my office is in Westport Plaza and my phone number is (314) 275-9160—just sayin’.) See what I mean? The more people know you, the more likely they are to use your products or services or refer a friend who needs you.
But let’s talk about the tax implications with hiding your identity. You might even be thinking, gosh, how would a person even do that in the first place? This is where you hire a third party in another state to file your EIN for you– this keeps your personal identification off of your federal corporate registration. It doesn’t really sound like such a bad thing, really. You might even be thinking that sounds like a good idea, but it’s not if you’re running a legitimate business!
If you try to hide your identity, the IRS sees it as a red flag for things like: underreporting, not filing returns, money laundering, financial crimes, and my personal favorite: financing terrorists. How’d you like to be delayed at the airport because you wound up on a terrorist watch list because you incorporated in another state? Okay, I’m pretty sure that you’d have to do more than just incorporate in Nevada to wind up on a terrorist watch list. But the point is, why flag your business that way?
I know I post a lot of ideas on saving money on taxes. I preach the “don’t pay more than you have to” sermon all the time. But you should never do something as a tax strategy that isn’t also good for your business too. You remember the old acronym KISS? (Keep it Simple, Stupid!) If you have a small, one owner (or husband and wife) business working in a local market, you really have no need to be filing tax documents out of state.
It’s that time of year again when the IRS audit letters are hitting people’s mailboxes. And one of the most popular letters is reminding folks that they forgot to include their cancelled debt on their income tax returns.
“But why should I have to pay tax on that?” That’s got to be the most common question I hear from folks. “It’s not like the credit card company gave me any money, they just cancelled my debt.”
Let me try to explain it the way the IRS looks at it: If you have a job and you make $30,000 you have to pay income tax on that $30,000 right? Because it’s income to you, you pay income tax. I think that makes sense to everyone (You probably don’t want to pay the tax, but you understand the concept).
When you take out a loan for $30,000, you don’t pay tax on it. The $30,000 is a loan and you are supposed to pay it back, so it doesn’t count as income. That makes sense too.
Now let’s say you take out a loan for $30,000 and you don’t pay it back. We’ll skip past the nasty phone calls from the creditors and go straight to the part where the debt is forgiven. The bank says, “Okay fine, we’re going to write off the debt, you don’t owe us anymore.” Well now that $30,000 isn’t a loan anymore, because you don’t have to pay it back. Once that loan is no longer considered a loan—the IRS counts it as income and you get taxed.
But what if I didn’t take out a loan, what if it was just a credit card? It still gets treated like a loan because essentially, that’s what your credit card does for you. It gives you little loans to buy shoes, or a TV, or groceries. If your credit card debt is forgiven, it gets taxed.
So if I get an IRS letter saying I owe taxes on cancelled debt, do I automatically owe the money? Not always. There are some situations where you might not have to pay the tax, or maybe get the amount reduced. The biggest exclusion is if your home is foreclosed on. If you lived in the house as your main home and you lost it to a bank foreclosure, you can have the principal part of the mortgage that was forgiven be excluded from your income (That can be a pretty hefty tax chunk right there).
Another exclusion is for debt that was discharged in a Chapter 11 bankruptcy. So if you’re in the middle of bankruptcy proceedings, you’re going to want to be sure to claim the bankruptcy exclusion.
The third common exclusion is for “insolvency.” Insolvency means that your liabilities (money you owe) just before the debt was discharged is more than your assets (things of value like cash, stocks, your house, your car, etc.)
There are other exclusions, but these are the three most common ones. If you think that you may qualify for one of these exclusions, then you’ll want to amend your tax return showing that you’ve claimed the exclusion. You’ll put that on a form 982: http://www.irs.gov/pub/irs-pdf/f982.pdf This is one of those cases where I recommend that you have a professional work on the return. There are a lot of little details that go into the exclusion of debt that just won’t fit into a short blog like this. If you’re pretty handy with tax issues, the details can be found in IRS publication 4681: http://www.irs.gov/publications/p4681/index.html
I was recently asked, “How do I go about hiring my Mom to be a nanny?” Unlike me, who would just try to pawn my kids off on my Mom whenever I got the chance, this person wanted to make it official: 1. She wanted to pay her mother for the work, and 2. She wanted to make sure all the tax stuff was handled properly. If you’re thinking about hiring your Mom (or your Dad) here’s what you should know.
First, when you hire your parent for domestic work (including child care, housekeeping, etc.) your parent is exempt from social security and medicare withholding. This makes the whole “hiring your parent” thing a lot easier. There is an exception though, and I think a lot of families might fall into this category:
If you meet both of these conditions: 1. Your parent cares for your child who is under 18 or is disabled and 2. You are either divorced or widowed and not remarried, or your spouse is permanently disabled. Note: the rules don’t say anything about if you were never married, just divorced or widowed. So, if you meet these conditions, then you do pay the payroll taxes. Otherwise, just pay your mom every week. She can report the income on her tax return and you can report that you paid her and claim the child care credit. Super easy, right?
If you do have to do the payroll withholding, it’s not that hard. For 2011, you’ll want to withhold 5.65% to cover the employee’s share of payroll taxes. You’ll wind up matching that amount when you file the Schedule H with your tax return (the household employee tax.) You have the option of paying your Mom’s share of the employee tax and not withholding it from her pay. (You just don’t withhold and you pay double the employer’s tax, still pretty easy.)
You do not pay FUTA (federal unemployment taxes) on your parent no matter what the circumstance.
You may be required to pay state unemployment insurance, you’ll have to check with your state. Here in Missouri, you’ll pay unemployment insurance if you pay your parent over $1,000 per quarter.
You will need to provide your parent with a W2 after the year is over showing the income paid, whether you withhold the payroll taxes or not.
For more information of household employees, check out the IRS publication 926 at http://www.irs.gov/publications/p926/index.html.
To check out the Schedule H, click on this link: http://www.irs.gov/pub/irs-pdf/f1040sh.pdf
Addendum: shortly after I posted this blog, I read an article about nanny’s that get paid over $150,000 a year. If you pay your nanny over $106,800, then you don’t need to withhold the social security tax on any amount over that. (You still withhold the medicare.) If you do pay your nanny that amount, I’d just like to point out that not only am I really good with children, but I can also prepare my own payroll and to all the associated tax forms that go with it. (Just saying.)
I hate bookkeeping! I know, you probably found this site looking under “accountants” but I hate doing bookkeeping. I’ve found that many other small business owners do too. So if you’re like me, you want to keep your bookkeeping time spent to a minimum so you have more time to work on the part of your business that you love. Here are some of my tips to keep things simpler:
Make a separate bank account for your business and keep it apart from your personal money. Income goes into the business account, expenses go out of the business account. If you do this one step, your bank statements become a perfect record of your business.
What if I accidentally make a business purchase with my personal funds? Write yourself an expense report, just as if you were working for a major corporation- attach receipts, and write a check to yourself as an “expense reimbursement.”
What if I need to take money out of my business account to pay for personal stuff? Once again, you write yourself a check, label that as “owner’s draw”. One business owner I know writes checks for his reimbursements and uses account transfers for his draw so that it’s easier for him to keep track of what is what. The important thing to remember is that your draw is not an expense, that’s part of your profit.
Never take cash out of your business account with your atm card. Never.
What if I don’t have enough money to pay my business bills with my business account? Can I pay my business bills with my personal checking account? No. You should write a check from your personal account to your business account and pay the bills from there. Keep track of that. When your business is doing better, you can reimburse yourself.
I get a 1099 at the end of the year and I write less than five checks a month for expenses, if even that. Do I really need a separate bank account? In a case like this, probably not, you could get away with a handwritten log of your expenses. The point is to do what’s easiest for you, in this case separate accounts might be more of a headache.
I’ve got the opposite problem. I’ve got lots of little expenses from all over the place. It takes me hours to load it all into Quickbooks. Any help for me? Maybe, here’s a tip I learned from one of my clients that might work for you. This fellow had lots of expenses, but the vast majority of them fell into two categories: production and shipping. He got two credit cards, the Visa he used exclusively for his production expenses, and the Mastercard for shipping. Any other expenses he put on his debit card or wrote checks for, but they were minimal. Each month, as he paid his credit cards he entered that one expense as his production or shipping expense instead of the dozens of smaller charges that he had been entering. If you’ve got a business where you can group your expenses like that, this might be helpful for you. Make sure you save all your receipts in a file with your credit card statements to back up those entries in case you get audited.
If you’ve found a tip that helps you keep your small business bookkeeping simple, please share it here. Thanks.