Tiny business owners, you know who you are: you’re a single member LLC or sole proprietor, or maybe you’re in business with your spouse. You might even have an employee or two, but that’s about it. When Congress passes laws to help “small business” they don’t mean us. This post is for you. If you are a Sub-chapter S corporation, I’ve got tips here: http://robergtaxsolutions.com/2011/12/2011-year-end-tax-tips-for-your-single-owner-sub-chapter-s-corporation/
Number 1: If you’re going to be in the red for this year, you don’t really need to worry about reducing your business tax, right? Your negative business income will help offset your other income (if you’re lucky enough to have some). You can devote your energy to being profitable next year.
Number 2: If your business is in the black, congratulations! You’re going to want to look at cash flow and make sure you’re got enough cash to pay your upcoming expenses (like payroll and payroll tax if you’ve got it), but let’s look at some ways to reduce your excess income before the year is out.
Hire your kids: If you’ve got kids under the age of 18, you can hire then without having to pay FICA. It used to be if you had an LLC, you paid FICA for your kids but that changed in 2011 so even if you have an LLC, you don’t pay FICA on your children’s wages. There are rules that have to be followed, but if you could use a little help at work this time of year you’d at least be keeping the money in the family. For more information check this: http://robergtaxsolutions.com/2010/12/last-minute-tax-tip-hire-your-kids/
Pre-pay business expenses: Most tiny business owners use something called “cash basis accounting”, basically, you’re taxed on what comes in versus what goes out. If you are cash heavy, you can pre-pay some of your business expenses for up to twelve months. For example: I lease my office space, I’ve got a one year contract so I know that I’m going to have that monthly expense for the rest of the year. If I were cash heavy (in my dreams) I could prepay my rent for the entire 2012 year and write it off on my 2011 taxes. But you see how you can play with that? While I won’t be paying a full year of rent in advance, I did pay a few January bills early.
Delay invoices: Remember, this only works if you’re cash flush. Let’s say you did a job and a client owes you $1000 and you normally would send out the bill with a due date of December 30th. Change to due date to January 15th—you’re pushing that income ahead to next year. Besides, your client might just appreciate the break at Christmastime. I set up a billing schedule for a client that didn’t start until January and I used “I thought you could use a little Christmas break.” She was thrilled and I delayed the income—talk about a perfect win/win situation.
Credit card purchases: According to IRS rules, if you buy something with a credit card, you’ve bought it now. So, let’s say you’re a little cash poor right now but you’ll have the revenues next month to cover your expenses. Pay expenses with your credit card and it will count as having been paid when charged. I always like to be cautious about credit card spending–hate those bills, but it’s a good solution for some businesses.
This one I don’t like to say, but buy equipment: If you need it. I almost hate to list this as advice because it’s the standard that everybody says every year. One of my clients fired his old accountant for saying it. Like he said, “I know what I do need and don’t need to run my business and I don’t need any more equipment. What other ideas you got?” In this same category is the buy a new SUV that weighs over 6,000 pounds so you can use 100% bonus depreciation to write off the whole thing. Here’s my advice, “Don’t buy crap you don’t need.” If you do need equipment, and you’re profit heavy, it’s better to buy in December than in January. But buy what makes sense for the business.
Get your retirement plan in place: If you’re just investing in an IRA, you don’t need to worry about that yet, you’ve got until April. If you’ve been wanting to set up a SEP or a 401(k), you need to get that done by December 31st. Contact your financial advisor about setting up your retirement plan.
Last, because this isn’t really business: charitable contributions. If you’re a sole proprietor, your charitable contributions do not count as business expenses. So if you give money to the Salvation Army, that’s a personal deduction, not a business deduction. Every year, I see a lot of people trying to claim their charitable contributions as business expenses and it won’t fly with the IRS. Even if you pay a charity from your business bank account, it’s not allowed as a business expense. Charitable contributions won’t help reduce your self-employment taxes. Please give to charities and give generously, but know that it’s a personal deduction, not a business one.
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’ve skimmed through my other blog posts, you might notice that I have lots of tips for people with children, people who are old, or people with various family situations. What you don’t see is much about people who are single and working. This post is for you.
If you’re a young adult out on your own, earning wages, and living in an apartment, you’ve probably noticed that you don’t have many tax deductions to work with. The three most likely things you might qualify for are the student loan interest deduction, the IRA deduction, and the retirement savings contribution credit. Other than that, unless you’re ready to buy a home, you usually don’t have much to work with. But let’s take a look at these three items.
Student loan interest deduction: if you’ve finished college, or are at least temporarily out, you’re probably paying student loans. The most you can claim per year for this deduction is $2,500—now that’s for the interest you pay, not the principal. I often find people trying to claim everything they paid and that won’t fly. You can only use the amount on your form 1098E that you get in the mail.
Now if you’re single and you make less than $60,000 per year, then you can claim the full amount of your deduction. If you make over $75,000 you lose the deduction completely. For those of you inbetween, you’re in what’s called the phaseout range. It’s a funky equation, bottom line, the closer you are to $75,000, the less you’ll be able to claim.
IRA deduction: My Dad always used to lecture me about saving for retirement. Now that I’m older, I just recycle his lecture. (I’m sure he doesn’t mind.) If you don’t have a retirement plan at work, you can put up to $5,000 into a traditional IRA and that money will not be subject to income tax. Let’s say your income was $50,000 a year. With just your standard deductions, your total tax would be $6,350. (Now hopefully you’ve been withholding all year and you wouldn’t have to pay in that much, that would be your total tax liability.)
But if you put $5,000 into an IRA, then your tax liability would go down to $5,100. By saving money for your retirement, you’d also save $1,250 off of your tax bill. That’s a pretty good bang for your buck.
If you do have a retirement plan at work, you can just reduce your taxable income by putting money into your 401(k) plan there. It works a lot like the traditional IRA. One thing to remember, if you do have a retirement plan at work and you make over $66,000 then you won’t be able to claim a deduction for an IRA contribution. You can still claim a full deduction if you make less than $56,000, and anything in between puts you into that “phase out category”.
Retirement Savings Contribution Credit: Putting money away for retirement can be especially helpful taxwise if you qualify for the Retirement Savings Contribution Credit. You can only claim this credit if you income is $27,750 or less though and you cannot be a full time student. So, if you graduated in May and started working in June you wouldn’t be able to claim the Saver’s credit this year. (But then we’re looking at the Education credit so that’s usually a better deduction anyway.)
The credit is worth between 10% and 50% of your retirement savings contribution. The maximum contribution you can claim is $2,000—so even if you put $5,000 into your IRA, you could only claim $2,000 towards the credit. The percentages work like this; if you made less than $16,750 you can claim 50% of your contribution. Up to $18,000 you claim 20%, and over that you get a 10% tax credit.
So let’s say you made $25,000 and put $1,000 into an IRA. You’d qualify for a $100 tax credit (1,000 times 10% is $100.) Another cool thing about this credit is that you can mess around with it. Let’s say that you make $28,000—oops, you can’t get a Saver’s Credit. But wait, if you put $1,000 into an IRA now your income is only $27,000 and you do qualify.
You don’t get a lot of tax savings options when you’re working and single, but it’s important to know what is available to you and how to make to most out of what you’ve got.
This year seems to be the year that seniors are getting slammed from all sides. First, there was no increase in Social Security benefits, but the Medicare premium they had to pay was increased leaving them with smaller checks. Last year we had a brief, additional federal tax deduction for real estate taxes which was specially designed to help senior home owners, but that was eliminated for this year.
Here in Missouri, the state recently ended the Historic Preservation Credit, which helped control senior’s real estate tax bills. And right now they’re trying to end the popular Property Tax Credit for seniors who rent instead of own their homes. (Some seniors have already felt the bite of this as the credit is now denied to seniors of subsidized housing.)
So instead of just harping on bad news, what are some tax tips and strategies that are available to senior citizens? First, even if you don’t make enough income to be required to file, file a federal return anyway. Why? Two reasons, the first is that you’re on the radar in the event the government offers some sort of tax rebate or credit for senior citizens. Many seniors missed out on the $250 rebate a few years ago just by not filing. Second, and this is probably even more important, is that if you file a return, there’s a statute of limitations where the IRS can’t come back after you for more money. If you don’t file a return, there is no statute of limitations. I’ve had to deal with seniors who now have tax liens on their homes because they didn’t file a return and the IRS came up with something years later. Had a timely return been filed, the IRS would have been too late to make the claim.
Another important strategy for seniors is planning their income. Depending upon your marital status, your social security becomes taxable once you reach a certain income. You don’t have much choice about how much you receive for your pension, and you’re required to take your minimum required distribution from your IRAs, but you have a lot of flexibility elsewhere. Right now, during the early part of 2011 is a good time to plot out your strategy for your next year’s tax return. If you’re anywhere near the borderline on taxable social security, planning is absolutely essential. Some strategies include: moving assets to a tax free munincipal bond fund, using the charitable donation option on your IRS to use your required minimum distribution, and selling stocks that have lost value to offset your capital gains.
A flip side strategy for some seniors would be if you’re already in a situation where 85% of your social security is going to be taxed, go ahead and do even more taxable transactions. This sounds crazy coming from me as I’m always trying to defer income and taxes, but hear me out. When you’re in the “taxable social security zone”, you’re really paying a double tax. If you’re in the 15% tax bracket, then you’re really paying 30% because that social security wasn’t taxable until you hit the zone. If you’re pushed into the 25% tax bracket, that extra income is really taxed at 50%. 50%! So, let’s say you have a year where you’ve already reached the point where 85% of your social security is going to be taxed. Once you’ve crossed that line, the IRS can’t tax anymore of your social security for that year, the remaining tax will be at the regular rate (25, 28 or 32% so it’s a tax reduction now.) It might just make sense to go ahead and do that extra income transaction now, if it will keep you from having to be in the extra tax zone next year. It’s really going to depend upon your individual situation
Updated for 2013
Congratulations on getting married! It’s so fun to start out your new life together, but it’s a big adjustment too. One of those really difficult adjustments is learning a new phrase, “Our money.” You already know “your” money and “my” money, but the whole “our” money concept is a little difficult to grasp sometimes. Hopefully, this will help with the tax side of that at least.
Pick the right filing status: It doesn’t matter how long you’ve been married for, if you were married on December 31st you are considered married for tax filing purposes. For most couples, your best bet is to choose the Married Filing Jointly tax status, it will usually give you the best tax rate. There are times though, when it may make sense to use the married filing separately status. For example: if one of you has an income tax problem from before the marriage, it might make sense to file separately until the tax issue is cleared up. Many accountants will tell you to just file jointly and file an injured spouse claim. I often recommend that too. But if filing separately isn’t going to hurt your taxes very much, I prefer keeping your tax matters completely separated until the old tax issues are erased. It’s just a safety precaution. When you file separately, you know exactly what money you’ll get back from the IRS, when you file as injured spouse, the IRS makes the determination. I prefer keeping the control.
Now that you’re married, you cannot claim the Head of Household filing status. This is a common problem that I see with tax returns all the time. Couples who have been together for years and have a couple of kids decide to get married. They forget to change their filing status on their tax forms after they get married. Oops. Not only is it a mistake, but if you received benefits that you wouldn’t have gotten if you filed as married, then it’s considered income tax fraud. Don’t fall into that trap. Be sure to use one of the married filing statuses. (If the marriage goes belly up and you separate for the last 6 months of the year, then you might be able to file as HH, but this is the newlywed page.)
The good, the bad, and the ugly: The good part about married filing jointly is that you double your exemption and your standard deduction. Also, your tax rate is lowered. If you’re a newlywed and one of you is the wage earner and the other had little or no income, you’re going to have a great tax year.
The bad part is that with most young married couples today, both spouses are working. Your deductions may go up but really you’re just combining your two incomes so you really get no major tax break at all for being married.
Now here’s the ugly: For some couples getting married actually puts them in a worse tax situation than when they were single. For example, let’s day that Danielle and Jeremy were both in the 15% tax bracket when they were single, but combining their incomes puts them in the 25% tax bracket. If they didn’t make adjustments to their withholding, they could get hit with a nasty little tax bill in April.
Here are some other issues that you might not have thought about yet. First to the bride, did you change your name? If so, did you make it official with social security yet? If yes, then you’ll be able to file your tax return with your new name. If not, make sure that you use your old name to e-file your tax return. If you don’t use the name that the social security office has on record for you, your tax return will be rejected.
The stupid question: Whose name is going to go on the top of the form? I warned you it was a stupid question. Does it matter? No. What does matter is that the name that’s on the top of the form will stay there. Some couples, especially if they have equal incomes, will change which name goes on top each year, seems fair doesn’t it? What they don’t realize is that the IRS looks at that as an attempt to cover up fraudulent activity. Generally, put the higher wage-earner’s name on top of the form and leave it there, even if your incomes change later.
Hopefully, you’re getting a refund. Aside from those wedding gift checks, this will be the first “joint” money you receive. That’s kind of cool. Do you have a joint bank account yet? The money will be in both of your names, so both of you should be named on the checking account for the money to be direct deposited. One thing you should know, although the IRS will direct deposit your tax refund into a single account of a married couple, some states and financial institutions won’t allow it. If your refund seems to have gotten held up, that could be the reason.
One last piece of advice: If you are getting a refund this year, it’s a great way to start putting away some money into savings. I know you’ve got bills to pay and things you want to buy, but saving now while you’re just starting out is the best thing you can possibly do for yourself. Allocate some money for spending, but get that savings cushion started and keep adding to it. You’ll be glad you did.
I just saw a news item on television: Couples with $10,000 of debt and zero savings are twice as likely to get a divorce as couples with $10,000 in savings and zero debt. The best thing you can do for your marriage is to have a little padding in that savings account. (End of mom-style lecture.)
There’ve been a lot a changes this past year with some states legalizing gay marriage, some authorizing civil unions, and of course the end to “Don’t Ask Don’t Tell” in the military. But despite all these changes, US federal tax law still does not recognize gay relationships in tax law. Even if you’re in a state where your marriage rights are fully recognized, you’ll still be considered unmarried for federal tax purposes and social security benefits. These tips are for couples who are legally married, or would be legally married if they lived in a state that allows gay marriage.
There are two main issues here that you have to deal with. The first is working to reduce your current tax liability and the second is to ensure that you’ve got sufficient coverage for both of your retirements. To that end, you need a tax professional and a financial advisor that can sit down with you and your partner to develop some long term and short term strategies. Right now, if you’re thinking, “I’d never even tell my tax guy I’m gay,” then it’s time to hire a new advisor.
Couples where both partners earn wages and have similar incomes: are pretty straight forward for tax purposes. You can both take advantage of IRA contributions, you’ll both receive equal social security benefits from your wage earning, you won’t lose any tax benefits from the married filing separately status, and your tax rates will be fairly comparable to folks filing as married. In this situation, many couples just split everything evenly and that’s a pretty fair arrangement. But, it may make sense to load all of the deductions onto one partner and let the other partner take the standard deduction.
For example: let’s say that Jen and Gina together would have itemized deductions of $13,000 a little more than the $11,400 they would claim as a standard deduction if they could file as married. Filing as single they can each claim a standard deduction of $5,700. If they’re splitting the itemized deductions, they can each claim a deduction of $6,500. But, if we load all of the deductions onto Jen and have Gina claim the standard deduction, then together they’d have a combined deduction of $18,700 and that would save them a substantial amount of money.
Now, remember, it’s not that perfectly even. In most cases, part of the $13,000 would be state income tax, you can’t load that onto your partner’s return, but with planning, you can put your mortgage, real estate tax, and charitable contribution deductions all on one person and enjoy a substantial tax savings.
Couples where there is self employment income: The biggest tax issue facing sole proprietors is paying the self employment tax. If you’re already in the 25% income tax bracket, and you add that 15% self employment tax to that, then you’re paying 40% tax on your income. Anything you can do to reduce your self employment tax is a good thing.
One possibility is to hire your partner as an employee. This in itself doesn’t really eliminate your self employment tax as you’re just shifting it to your partner and paying the employer’s share. But, hire your partner and provide health care benefits and now you’ve got something. For example: let’s say Jack and Dean have been together for 10 years. Jack has modest income from a part time job but spends a lot of time helping Dean with his small business as a professional entertainer. Dean is fairly successful and averages about $100,000 a year in income. Jack books appointments for Dean and makes sure that Dean is where he needs to be at all times. If Dean were to have to hire someone to do Jack’s job, he estimates that it would easily cost him $15,000 or more. So instead, he hires Jack as an employee. Instead of taking a salary of $15,000, Jack chooses a smaller wage but wants health insurance benefits. Because Jack would be Dean’s only employee, Dean can afford to have his employee package include health insurance benefits. And, more importantly, Dean could provide a health care plan that covered Jack’s partner (which happens to be Dean.) Now Jack and Dean have just excluded all of their health care costs from self employment tax.
Here’s why: Health care benefits reduce the employer’s taxable income. Health care benefits are not included in the employee’s taxable income. It’s a win/win situation for both of them.
Everyone’s tax situation is unique and the laws keep changing so you have to stay on top of things. Right now though, with the tax laws as they are, doesn’t it make sense to take advantage of them instead of letting them take advantage of you?