Starting your own business can be equal parts thrilling and intimidating. Complying with regulations and tax requirements definitely falls into the latter category. But, with some professional help, it doesn’t have to be that way. You can get started with this checklist of things you’ll need to consider.
Are you a hobby or a business? This may seem basic to some people, but the first thing you’ll have to consider when starting out is whether you really are operating a business, or pursuing a hobby. A hobby can look like a business, but essentially it’s something you do for its own sake that may or may not turn a profit. A true business is generally run for the purpose of making money and has a reasonable expectation of turning a profit. The benefit of operating as a business is that you have more tax tools available to you, such as being able to deduct your losses.
Pick your business structure. If you operate as a business, you’ll have to choose whether it will be taxed as a sole proprietorship, partnership, S corporation or C corporation. All entities except C corporations “pass through” their business income onto your personal tax return. The decision gets more complicated if you legally organize your business as a limited liability corporation (LLC). In this case you will need to choose your tax status as either a partnership or an S corporation. Each tax structure has its benefits and downsides – it’s best to discuss what is best for you.
Apply for tax identification numbers. In most cases, your business will have to apply for an employer identification number (EIN) from both the federal and state governments.
Select an accounting method. You’ll have to choose whether to use an accrual or cash accounting method. Generally speaking, the accrual method means your business revenue and expenses are recorded when they are billed. In the cash method, revenue and expenses are instead recorded when you are paid. There are federal rules regarding which option you may use. You will also have to choose whether to operate on a calendar year or fiscal year.
Create a plan to track financials. Operating a business successfully requires continuous monitoring of your financial condition. This includes forecasting your financials and tracking actual performance against your projections. Too many businesses fail in the first couple of years because they fail to understand the importance of cash flow for startup operations. Don’t let this be you.
Prepare for your tax requirements. Business owners generally will have to make quarterly estimated tax payments to the IRS. If you have employees, you’ll have to pay your share of their Social Security and Medicare taxes. You also have the obligation to withhold your employees’ share of taxes, Social Security and Medicare from their wages. Your personal income tax return can also get more complicated if you operate as one of the “pass-through” business structures.
This is just a short list of some of the things you should be ready to discuss as you start your business. Knowing your way around these rules can make the difference between success and failure, but don’t be intimidated. Help is available so don’t hesitate to call if you have any questions.
With all of the headlines about the changes to tax law, you probably have lots of questions. Here are answers to some of the most commonly asked tax questions taxpayers have this year.
Q. I’m hearing about a lot of changes to 2018 taxes. What should I do?
A. You’re right, there are a lot of changes in 2018 due to the passage of the Tax Cuts and Jobs Act (TCJA), including to the income tax brackets. The simple answer to the question, “What should I do?” is to not make any major changes until you finish filing your 2017 taxes. Once you understand your 2017 tax obligation, you are in a better position to plan for 2018.
However, there are a few things you can start thinking about now. Depending on where you fall in the new income tax brackets, you may want to consider ways to lower your taxable income. This could include increasing your contributions to 401(k) retirement accounts or health savings accounts (HSAs). You’ll also want to make sure your employer has adjusted your federal tax withholding so that you don’t have to wait to receive a large refund (or tax bill) next year. You can review the IRS withholding calculator using your latest pay stub data to make sure the changes are accurate.
Q. What is the penalty amount if I didn’t have health insurance in 2017?
A. The penalty per adult is calculated as the greater of either $695 or 2.5 percent of your yearly household income, up to a maximum of $3,264 for individuals or $16,320 for a family of five or more. Note that the penalty is still in place for tax years 2017 and 2018. The TCJA eliminates the penalty for 2019 through 2025.
Q. Is Social Security taxed?
A. It depends. You won’t pay tax on more than 85 percent of your Social Security income, but how much gets taxed depends on your income bracket. If your combined income is less than $25,000 for the year, you won’t pay tax on Social Security income.
Q. When is the last day to do my taxes?
A. Technically, Tuesday, April 17. But don’t wait until the last minute. Ask for help to get started now, or to file an extension so you have time to complete your tax return later. The sooner you file, the sooner you can get your refund. It usually takes about three weeks to arrive from the date you file. Also, remember you need to keep most tax related documents for at least three years, so don’t toss your paperwork after you file.
Q. The IRS contacted me, what should I do?
A. Ask for help. There are numerous scammers who impersonate the IRS during tax season. The real IRS will never contact you via social media, email or text message. In addition, an IRS agent will not contact you over the phone unless you first receive official correspondence in the mail. If you have received a notice in the mail, immediately ask for help to determine how to proceed.
These are just a few of the questions people have during tax season. If you have more, don’t forget to bring them to your 2017 filing appointment.
If you reached age 70½ last year, April 1 could be an important deadline. It’s the last day you can take your required minimum distribution (RMD) for 2017 from your traditional IRAs. If you miss that deadline, the penalty may be a 50 percent excise tax on the amount you should have withdrawn.
How the rules work
Once you reach age 70½, you must start taking annual distributions from your traditional IRAs. Normally these distributions must occur by Dec. 31 of each year. But a special rule lets you defer your very first RMD until April of the year after you reach age 70½. So if you turned 70½ last year, April 1 is the deadline for your 2017 distribution. Be aware that you’ll still need to take your 2018 RMD before the end of this year. Note that RMD rules don’t apply to Roth IRAs.
Generally, the amount of the RMD for any year is based on your age. You take the balance in all your traditional IRAs as of the last day of the previous year, and divide by a factor representing your life expectancy. The IRS has published a standard life expectancy table to use in the calculation. Special rules might apply if your spouse is more than 10 years younger than you are.
RMDs and tax planning
Because all or part of your distribution may be taxable income, it is important to include RMDs in your tax planning. Ideally you should start planning for RMDs several years before you reach age 70½. But whether you’re planning in advance or looking at a distribution on April 1, contact our office for more detailed advice.
If you’re still working, this deadline may also apply to your other retirement accounts.
Emotions make us human. They can also cause us to make rash decisions. Business owners and managers often let emotions dominate the decision-making process. This is especially true when choices are based on “sunk costs.”
Why sunk costs can lead to trouble
Broadly defined, sunk costs are past expenses that are irrelevant to current decisions. For example, many firms hire consultants who sell and install software. In some cases, a company is left waiting for years for a functional and error-free system. Meanwhile, costs continue to escalate. But are those costs relevant?
Managers, especially those who initially procured the software and contractor, may reason that pulling the plug on a failed contract would be wasting all the money spent. Not true. That money is “sunk.”
Other examples of sunk costs may be found in the areas of product research, advertising, inventory, equipment, investments and other types of business expenses. In each of these areas, companies spend money that can’t be recovered — dollars that become irrelevant for current decision-making.
Sunk costs are a waste of time — move on
Truth be told, the only relevant costs are those that influence the company’s current and future operations. Throwing good money after bad won’t salvage a poor business investment — or a poor business decision.
The tax law changes in the Tax Cuts and Jobs Act, passed at the end of December 2017, enacted some of the most sweeping changes taxpayers have seen in 30 years. Here are a few big changes to come out of the new act — and what you can do about it.
The medical expense deduction threshold was lowered to 7.5 percent.
The tax reform bill retroactively lowers the threshold to deduct medical expenses in 2017 to 7.5 percent of adjusted gross income. The previous threshold was 10 percent. This new 7.5 percent threshold remains in place for 2018, but reverts back to 10 percent in the following years.
What this means: You may want to consider using the medical expense deduction this year. If there are any qualified medical expenses you can make (drug purchases, medical equipment, etc.) to push you over the new, lower threshold, consider doing so in 2018.
The healthcare individual mandate penalty stays in place until 2019.
The shared responsibility penalty (also known as the individual mandate) in the Affordable Care Act is effectively repealed by the tax reform legislation, but not right away. The penalty is set to zero in 2019, but remains in place for 2018.
What this means:You still need to retain your Forms 1095 this year in order to provide evidence of your healthcare coverage. Without proof of coverage, you may have to pay the higher of $695 or 2.5 percent of your income. Unless there are further changes coming, 2018 may be the last year you’ll need to worry about the individual mandate penalty.
More changes to consider for 2018 tax planning
We’re experiencing some of most significant tax law changes since the 1980s. There will be a lot of things to consider for tax planning this year. Here are some of the most significant:
Reduced income tax rates
Doubled standard deductions
Suspension of personal exemptions
New limits on itemized deductions, including:
Combined state and local income, property and sales tax deduction limited to $10,000
Casualty losses limited to federally declared disaster areas
Elimination of miscellaneous deductions subject to the 2 percent of adjusted gross income threshold
Boosts to:
The child tax credit ($2,000 in 2018)
A new $500 family tax credit
529 education savings plan expansion for K-12 private school education
The estate tax exemption (doubled)
Stay tuned
There will surely be more details on the tax reform changes and how they are implemented by the IRS in the weeks to come. In the meantime, contact us if you have urgent questions regarding your situation.
Virtual currencies are all the rage lately. Here are some tax consequences you must know if you decide to dip your toe into that world.
The IRS is paying close attention
The first thing to know is that the IRS is scrutinizing virtual currency transactions, so if you live in the U.S. you’ll have to report your transactions in Bitcoins and the like to the IRS. Despite some early misconceptions, virtual currency transactions can be traced back to their owners by governments and other cyber sleuths.
If you decide to use or hold virtual currencies, carefully report and pay tax on your transactions. Act as if you are going to be audited, because if you don’t, you just might be!
It’s property, not money
Note that the IRS doesn’t consider Bitcoin or other virtual currencies as money, because they aren’t legal tender. Instead, they are considered property. That means that if you are paid in Bitcoin, you will have to report it as income based on its fair market value on the date you received it.
And, if you sell Bitcoin, you have to pay tax on your gain using the cost (basis) of when you received it. The IRS has said that if Bitcoin is held as a capital asset, like a stock or a bond, then you would pay capital gains tax. Otherwise, if it is not held as a capital asset (for example if it is treated as inventory that you intend to sell to customers), it would be taxed as ordinary income.
Be aware of the risk
In addition to the increased oversight by the IRS, virtual currencies are at risk of virtual theft with no recourse to a government agency like the Federal Deposit Insurance Corporation, which insures U.S. bank balances. Do your research on storage and security before you invest. And if you need help with any tax questions related to virtual currency, don’t hesitate to call.
The IRS is warning taxpayers to keep on high alert for the next few months for tax season scams. Scammers may try to get their hands on your money or tax return by collecting your personal or financial data. According to the IRS, its employees will never:
Threaten to immediately bring in local police or other law enforcement groups to have you arrested for not paying taxes you owe.
Demand that you pay taxes without giving you the opportunity to question or appeal the amount they say you owe.
Ask for credit or debit card numbers over the phone.
Remember, the IRS will typically mail you a bill if you owe any taxes. It doesn’t initiate contact with people via email or texts.
You’re probably getting ready to go through last year’s tax records and prepare for this year. But what should you keep and what can you throw away? Here are some things to keep in mind as you sort through your tax records.
Chances are you’re a little confused about what to keep and what to throw when it comes to tax and financial records. No worries. It’s time to sort through what you’ve got and keep only the important stuff. Here’s what to keep in mind:
Keep records that directly support income and expense items on your tax return. For income, this includes W-2s, 1099s and K-1s. Also keep records of any other income you might have received from other sources. It’s also a good idea to save your bank statements and investment statements from brokers.
The IRS can audit you within three years after you file your return. But in cases where income is underreported, they can audit for up to six years. To be safe, keep your tax records for seven years.
Retain certain records even longer. These include records relating to your house purchase and any improvements you make. Also keep records of investment purchases, dividends reinvested and any major gifts you make or receive.
Hold on to copies. Keep copies of all your tax returns and W-2s in case you ever need to prove your earnings for Social Security purposes.
There are many provisions in the tax reform bill passed in late 2017 designed to benefit small business owners. New capital expense rules are one of them. Also, There are a variety of new tax tools affecting how small businesses account for deducting the cost of capital purchases under the new tax law. Here’s what you need to know:
Tool #1: Section 179 deduction
The new law increases the amount of business property purchases that you can expense each year under Section 179 to $1 million (from $500,000 previously). Normally, spending on business property (machines, computers, vehicles, software, office equipment, etc.) is capitalized and depreciated so that the tax benefit is spread out slowly over several years. Section 179 allows you to get the tax break immediately in the year the property is placed into service.
Tips:
There is an eligibility phaseout for Section 179 that ensures it’s only used by small businesses, but that was also raised to $2.5 million (from $2 million) by the new law. If you spend more than $2.5 million on business property in total during the year, your ability to use the $1 million Section 179 deduction is reduced dollar-for-dollar above that amount.
Section 179 deductions can be used on both new and used equipment.
You can now use Section 179 on property used to furnish lodging or in connection with furnishing lodging (such as rental real estate). It also includes improvements to nonresidential real estate assets such as roofs, heating and air conditioning, and alarm systems.
Tool #2: Bonus depreciation
Bonus depreciation limits (also known as first-year bonus depreciation) are also improved under the new law, but for a limited time. Bonus depreciation is similar to Section 179 and allows you to immediately expense capital purchases rather than depreciating them over several years. Under the new law, first-year bonus depreciation increases to 100 percent of the qualified asset purchase price for the next five tax years (starting in 2018) and can now be applied to the expense of purchasing used property as well as new.
Tips:
Bonus depreciation is typically used on short-lived capital investments (with a 20-year or less useful life) such as machinery, equipment and software.
Bonus depreciation had been only for purchases of new equipment, but can now be applied to used equipment as long as you place it into service at your business during the tax year.
The allowable bonus depreciation starts to decline after 2022. It falls to 80 percent in 2023, 60 percent in 2024, 40 percent in 2025 and 20 percent in 2026.
Remember, though tax reform and these new capital expense rules give you expanded tools to accelerate depreciation, it may not benefit you to use them in every case. Sometimes it’s better to use the standard capitalization and depreciation tax treatment. These tax benefits do not change the amount a capital purchase can be expensed – only the timing. Calculating whether your business will benefit from these revamped expensing tools can get complicated, so give us a call if you need assistance.
Additional Note: Hawkinson Muchnick & Associates strives to provide small businesses with the information they need to optimize their tax situation and financial planning by publishing helpful articles such as this to social media. Please help us make this contribution by liking us on Facebook, as well as following us on Twitter and LinkedIn. Thank you!!
Getting audited by the IRS is no fun. Some taxpayers are selected for random audits every year, but the chances of that happening to you are very small. You are much more likely to fall under the IRS’s gaze if you make one of several common mistakes. So what is the best way to avoid an audit?
That means your best chance of avoiding an audit is by doing things right before you file your return this year. Here are some suggestions:
Don’t leave anything out. Missing or incomplete information on your return will trigger an audit letter automatically, since the IRS gets copies of the same tax forms (such as W-2s and 1099s) that you do.
Double-check your numbers. Bad math will get you audited. People often make calculation errors when they do their returns, especially if they do them without assistance. In 2016, the IRS sent out more than 1.6 million examination letters correcting math errors. The most frequent errors occurred in people’s calculation of their amount of tax due, as well as the number of exemptions and deductions they claimed.
Don’t stand out. The IRS takes a closer look at business expenses, charitable donations and high-value itemized deductions. IRS computers reference statistical data on which amounts of these items are typical for various professions and income levels. If what you are claiming is significantly different from what is typical, it may be flagged for review.
Have your documentation in order. Keep your records in order by being meticulous about your recordkeeping. Items that will support the tax breaks you take include: cancelled checks, receipts, credit card and investment statements, logs for mileage and business meals, and proof of charitable donations. With proper documentation, a correspondence letter from the IRS inquiring about a particular deduction can be quickly resolved before it turns into a full-blown audit.
Remember, the average person has a less than 1 percent chance of being audited. If you prepare now, you can narrow your audit chances even further and rest easy after you’ve filed.
