If you’re a business owner and your company lends you money, you’ll enter it in the books as a shareholder loan. However, if your return is audited, the IRS will scrutinize the loan to see whether it is really disguised wages or a dividend taxable to you as income.
Knowing what the IRS might look at may be useful when you structure the arrangement. Here are some items that will be considered if you’re audited:
Your relationship with the business. First, the IRS will look at your relationship to the company. If you’re the sole shareholder with full control over earnings, that may weaken your case that the loan is genuine. On the other hand, if you’re one of several shareholders and none of the others received similar payments, that suggests it may be a genuine loan.
Loan details. The IRS will want to know all the details related to your loan. This may include whether or not you signed a formal promissory note, if you pledge any security against the loan and if the loan has a specific maturity date or a repayment schedule. Other questions may come up about the rate of interest you’re paying and if you missed any payments. The more businesslike the terms of the loan, the more it will appear to be a genuine debt.
Other financial details. In addition to loan specifics, the IRS may ask you if your company is paying you a salary that’s in line with the work you perform, and if the company pays dividends.
Whether the IRS taxes you on the loan will depend on all these factors. If you’ve paid attention to the details, the loan should withstand IRS scrutiny. Contact us if you’d like more information about getting a loan from your business.
The advantage of filing a joint tax return is well known — couples generally save money when compared with filing separately. However, there is at least one potential disadvantage. Both spouses are liable for the entire income tax bill, including interest and penalties, even if one earned most or all of the income. Divorce changes everything.
The joint-filing downfall
This issue most commonly arises when there are unpaid taxes from joint-filing years, and a couple later separates or divorces. The IRS can pursue either spouse for the full amount. If you’re the easiest one to find, or if you have liquid assets, you can end up paying the entire bill.
When this happens, the only relief is called the innocent spouse rule. If you can prove that you had no reason to suspect tax shortfalls and you did not personally benefit from unreported income, or that you signed joint returns only under duress, you may get off the hook. Unfortunately, the IRS and the courts don’t often allow innocent spouse relief.
What can you do to head off trouble?
If your family spends much more money than the income shown on your tax returns, it’s an indicator that something’s not right. Ask questions if you don’t understand all the tax and financial issues in the joint return. In certain circumstances, you may even want to consider hiring your own tax professional to advise you before signing.
If you are headed toward separation or divorce, it may be best to file separately. You may pay a little more tax, but that’s better than leaving yourself liable for the tax issues of someone who is no longer on your side. Don’t sign a joint return unless you’re sure that all income has been reported and that the taxes have actually been paid.
IRS audit rates declined last year for the sixth year in a row and are at their lowest level since 2002, the agency reported. That’s good news for people who don’t like a IRS audit (which is everybody)!
Low statistics for audit examinations obscure the reality that you may still have to deal with issues caught by the IRS’s automated computer systems. These could be math errors, typos or missing forms. While not as daunting as a full audit, you need to keep your records handy to address any problems.
Average rates are declining, but audit chances are still high on both ends of the income range: no-income and high-income taxpayers.
No-income taxpayers are targets for audits because the IRS is cracking down on fraud in refundable credits designed to help those with low income, such as the Earned Income Tax Credit (EITC). The EITC can refund back more than a low-income taxpayer paid in, so scammers attempt to collect these refund credits through fraudulent returns.
High-income taxpayers have increasingly been a target for IRS audits. Not only do wealthy taxpayers tend to have more complicated tax returns, but the vast majority of federal income tax revenue comes from wealthy taxpayers. Based on the statistics, the very highest income taxpayers can assume they will be audited about every six years.
Complicated returns are more likely to be audited. Returns with large charitable deductions, withdrawals from retirement accounts or education savings plans, and small business expenses and deductions are reportedly more likely to be the subject of an audit.
The Tax Cuts and Jobs Act (TCJA) was passed by Congress in a hurry late last year, and the IRS and tax preparers have been working to digest some of the more thorny issues created by the tax overhaul. Here are the latest answers to some of the most common questions:
1. Is home equity interest still deductible?
The short answer is: Not unless you’ve used the money to buy, build or substantially improve your home.
Before the TCJA, homeowners were able to take out a home equity loan and spend it on things other than their residence, such as to pay off credit card debt or to finance large consumer purchases. Under the old tax code, they could deduct interest on up to $100,000 of such home equity debt.
The TCJA effectively writes the concept of home equity indebtedness out of the tax code. Now you can only deduct interest on “acquisition indebtedness,” meaning a loan secured by a qualified residence that is used to buy, build or substantially improve it. If you have taken out a home equity loan before 2018 and used it for any other purpose, interest on it is no longer deductible.
2. I’m a small business owner. How do I use the new 20 percent qualified business expense deduction?
Short answer: It’s complicated and you should get help.
Certain small businesses structured as sole proprietors, S corporations and partnerships can deduct up to 20 percent of their qualified business income. But that percentage can be reduced after your taxable income reaches $157,500 (or $315,000 as a married couple filing jointly).
The amount of the reduction depends partly on the amount of wages paid and property acquired by your business during the year. Another complicating factor is that certain service industries including health, law, consulting, athletics, financial services and accounting are treated slightly differently.
The IRS is expected to issue more clarification on how these rules are applied, such as when your business is a mix of one of those service industries and some other kind of business.
3. What are the new rules about dependents and caregiving?
There are a few things that have changed regarding dependents and caregiving:
Deductions. Standard deductions are nearly doubled to $12,000 for single filers and $24,000 for married joint filers. The code still says dependents can claim a standard deduction limited to the greater of $1,050 or $350 plus unearned income.
Kiddie Tax. Unearned income of children under age 19 (or 24 for full-time students) above a threshold of $2,100 is now taxed at a special rate for estates and trusts, rather than the parents’ top tax rate.
Family credit. If you have dependents who aren’t children under age 17 (and thus eligible for the Child Tax Credit), you can now claim $500 for each qualified dependent member of your household for whom you provide more than half of their financial support.
Medical expenses. You can now deduct medical expenses higher than 7.5 percent of your adjusted gross income. You can claim this for medical expenses you pay for a relative even if they aren’t a dependent (i.e., they live outside your household) as long as you provide more than half of their financial support.
Stay tuned for more guidance from the IRS on the new tax laws, and reach out if you’d like to set up a tax planning consultation for your 2018 tax year.
Wedding season is upon us. Did you know couples often enter into marriage without ever having had a discussion about financial issues? As a result, they find themselves frequently arguing about money. If you are planning a wedding, here are some steps you can take to get your marriage off to a good financial start:
Determine your financial compatibility. Take some time to discuss your finances before you tie the knot. Talk about your assets, debts, credit ratings and your financial attitudes, including your spending and saving habits. Do you share the same goals? Talk it out and see where you two align and where you differ.
Make a plan for how to handle finances after you say “I do.” This means figuring out day-to-day stuff, like who will pay the bills and whether or not you’ll maintain joint or separate checking accounts.
Involve your financial advisors. Every couple needs to work out their own style for handling money. Call us to assist you in setting up a budget, controlling your taxes and mapping out a financial plan for your future.
Discuss any related legal matters. If you have substantial assets, talk about the merits of a prenuptual agreement with your attorney. And ask your attorney how you can protect yourself from your partner’s credits if they have substantial debt. Perhaps you plan on buying a house together or combining financial accounts. Your attorney can advise you on the best way to hold title to your assets.
Discussing your finances before you wed may increase your chances for living happily ever after. Give us a call if you would like assistance in this area.
If you’re a business owner, one of the first questions to ask yourself is whether you should incorporate or not.
The biggest advantage of incorporating is that it limits your legal liability. Your responsibility for debts and other liabilities incurred by a corporation is generally limited to the assets of the business. Your personal assets are not usually at risk, although there can be exceptions to this general rule. The trade off is that there is a cost to incorporate and, in some cases, tax consequences.
So, should you incorporate or not?
Truth be told, you might not need to incorporate. Depending on the size and type of your business, liability may not be an issue or can be covered by insurance. If so, you could join millions of other business owners and operate as an unincorporated sole proprietor.
If you do decide to incorporate, you’ll face a choice of corporate forms. All offer limitation of your liability, but there are differences in tax and other issues. Take a look at the options:
C corporations. The traditional form of corporation is the C corporation. This type of corporation has the most flexibility in structuring ownership and benefits. Most large companies operate in this form. The biggest drawback is double taxation. First the corporation pays tax on its profits; then the profits are taxed again as they’re paid to individual shareholders as dividends.
S corporations and LLCs. These forms of corporations avoid this double taxation. Both are called “pass-through” entities because there’s no taxation at the corporate level. Instead, profits or losses are passed through to the shareholders and reported on their individual tax returns. S corporations have some ownership limitations. There can only be one class of stock and there can’t be more than 100 shareholders who are U.S. citizens or U.S. residents according to tax law. State registered LLCs have become a popular choice for many businesses. They offer more flexible ownership rules than S corporations, as well as certain tax advantages.
Whether you’re already in business or just starting out, choosing the right form of business is important. Even established businesses change from one form to another during their lifetime.
Call our office (and your attorney) for guidance in selecting the form that is best for your business.
