Tackling Small Business Taxes

Tackling Small Business Taxes
November 9, 2014

Q: What’s a good way to get a handle on small business taxes?


A: While you should have a good CPA on your team, every business owner needs to have a good understanding of the fundamental business tax rules to plan and operate their business.

Though the IRS may be the agency everyone loves to hate, they only manage the tax laws and policies that Congress passes. To its credit, the agency provides owners and the self-employed much-needed guidance to tax procedures and requirements without those confusing “Gov-speak” terms. Their special Web site, www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/ is an authoritative place to give you a tax smarts tune-up.

A section called “A-Z Index for Business,” for example, covers a tremendous amount of tax territory and includes much of the site’s most useful information. This is where you’ll find information on online learning and educational products, recordkeeping, employer ID numbers and selecting a business structure.

The advice and information under “Starting, Operating, and Closing a Business” is helpful for most types of small businesses. If you have employees, you’ll find resources on hiring, employment taxes and wage reporting requirements. Learn about business tax credits and estimated taxes. The all-important “Business Expenses” section defines the types of costs you can and cannot deduct from your taxes.

For the self-employed and independent contractors, there’s a full section that covers filing requirements, when a tax identification number is necessary, a listing of special publications and forms, and other valuable information.

For information on business taxes in the state of Texas, a good place to start is the web site of the Texas State Comptroller, www.window.state.tx.us/. Here you can find out if your business is subject to the Texas franchise or sales and use tax, calculate what your franchise tax might be, apply for your sales tax permit online, file and pay sales tax electronically, and where to call for help.

For employer information on who must pay, how to file and how to pay Texas state unemployment insurance taxes visit the Texas Workforce Commission web site, www.texasworkforce.org.

To learn more, attend SCORE’s Small Business Tax Workshop on November 19 at the Kingdom Builders’ Center. Presented by Gregory E. Vernon, CPA, you will receive up to date information on taxes and can meet one-on-one with a mentor to discuss your unique situation.

IRS Audit Rates and the Audit of the Future

A few weeks ago the IRS Commissioner threw a very public fit over decreases in the IRS’s proposed enforcement budget.  He publicly announced that audit rates would decrease for the foreseeable future.  His announcement was like the FBI announcing that it won’t prosecute bank robberies for the next year.  The decrease in audit rates may seem like good news for taxpayers, but the audit rate is no longer a meaningful measurement of IRS enforcement.

The audit rate for personal tax returns is already effectively 100%.  When you file your return, electronically or otherwise, the IRS computer matches the amounts from your return against their electronic files of W-2 forms, 1099 forms, and any other data required to be reported annually to the IRS.  So if you forgot to include income from your brokerage account, you don’t need to be audited to be caught.  The IRS computer notes your omission and sends you a tax assessment – along with penalties and interest.

Over the past ten years the IRS spent millions and millions of dollars creating an electronic tax enforcement system.  The electronic system functions as an audit, even if not called an audit.  The IRS no longer needs human agents to catch your mistakes.  So I you consider that all personal tax returns go through the electronic enforcement system, the actual audit rate for personal tax returns is really 100%.  The system has blind spots and makes a lot of mistakes, but it assesses hundreds of millions of dollars annually, and every year the IRS enhances it to match more tax forms against your return.

This electronic audit is the audit of the future.  You could even consider it the audit of the present since the IRS relies on it so heavily. today  Here’s the bad news.  Since the IRS relies so heavily on automated enforcement, it no longer has the staff to deal with all of the errors and discrepancies created by the IRS computer.

For instance, what happens if someone sends you a 1099-MISC form for $4,000 when they only paid you $3,000?  First you get an assessment notice for taxes, penalties, and interest from the automated enforcement system.  The IRS computer considers all 1099 forms as handed down from God.  Those of us in the tax business know the error rate on 1099-MISC forms is probably 25%.  People suck at bookkeeping.

Next, you write a letter responding to the assessment stating that you only received $3,000 not the $4,000 reported on the form.  If you’re really smart, with the letter, you enclose proof that you only received $3,000.  The other way to resolve the problem is to threaten the issuer of the form into sending a corrected form to the IRS.  The result is the same either way.

Three to six months later, you will receive a response from the IRS.  Hopefully, they’ll remove the assessment after your first attempt, but maybe not.  Then you’re in for another three to six months of waiting.  In the meantime, the IRS computer considers your assessed tax balance outstanding and undertakes automated collection efforts against you.  They won’t just lose the assessment as they claim to have lost Lois Lerner’s e-mails about targeting conservative groups.   You might have your bank account drained by the IRS before they can correct their error.  This is why the decreased IRS enforcement budget shouldn’t please you.  It might cost you money.

Staying out of tax trouble in the world of electronic tax enforcement requires prevention not reaction.   First, you have to effectively retain all of the tax records you receive.  We frequently ask clients about income from a source that we had last year for which we don’t have a form in the current year.  You can’t just glibly answer, “I didn’t get a form from them this year.”  If the IRS has the form, you’ll enter the gates of electronic enforcement hell.

Second, you must understand how the IRS processes electronic tax forms and where they expect the income from the forms to appear on your tax return.  If you understand this, you can easily handle incorrect forms.  For instance in the situation above where you received an incorrect 1099-MISC form, you would report the $4,000 on the schedule C income line where the IRS computer expects to see it.  Then you deduct $1,000 as an expense titling it “incorrect 1099-MISC amount.”

You decide by your diligence whether the IRS audit of the future targets you.  You can spend hours trying to fix issues noted by the IRS computer.  Or you can be a little more diligent about tax record keeping and keep the IRS computer from bothering you.  Your choice.

As always, thanks for reading!  For real tax and accounting advice, please visit the main S&K web site at www.skcpas.com.  Also please like the How to Screw Up Your Small Business Facebook page.  I post tax and accounting hints there daily.

Until next time, let’s do it to them before they do it to us.

The New Tax Act Vampires - Avoiding the Bite

The ghosts and ghouls, the witches and zombies have vanished as surely as your candy jar emptied.  The Halloween decorations are stored in the closet until next year.  However, not all the blood sucking vampires disappeared.  The income tax provisions of the Affordable Care Act still wait to drain your bank account by year end.   Worst of all, a number of the provisions may combine in unexpected ways to cost you thousands in additional taxes.  Careful planning  before year end might save you some financial hemoglobin.

The new income tax provisions feed on varying measures of income.  For instance, the new 0.9% Medicare surcharge on earned income sinks in its fangs when your wages and self-employment income exceed $250K ($200K for single taxpayers).  The painful 3.8% Medicare surcharge on investment income bleeds you when your adjusted gross income exceeds $250K ($200K for single taxpayers).  You can't even count on the 15% long term capital gains tax rate any more.  The new long term capital gains rate of 20% will bite you if your taxable income exceeds $450K ($400K for single tax payers).  The new tax rate of 39.6% starting for taxable income above $450K ($400K for single taxpayers) is another painful pint for Count Dracula.

Worse yet is how these provisions combine for even more serious financial blood letting.  For example, let's say you want to sell a piece of commercial real estate where you have a modest gain of $200K.  If your taxable income, as a result of the sale, exceeds $450K, your capital gains tax rate goes up from 15% to 20%.  But's that's not enough blood loss.  To the extent that the gain drives your adjusted gross income above $250K, you'll get bitten for the 3.8% Medicare surcharge on your investment income over the $250K.  That includes the real estate gain.  If your income would have otherwise been below $250K, not only does the federal capital gains tax rate go from 15% to 20%, but you get to pay the additional 3.8% Medicare tax for a total tax bite of 23.8%.  But the bite goes even deeper.  The gain can subject any of your other investment income to the same 3.8% fang marks.

Another painful bite from the gain on your property comes from the return of the phase out of itemized deductions based on income.  Your capital gain substantially increases your income and will thus reduce your itemized deductions such as mortgage interest and real estate taxes.  Your actual federal tax rate on the property sale could come close to 30% after taking into account all of the interactions between facets of the new law, which is a never satisfied vampire.

If you own a company that annually pays you a bonus to reduce company taxes, the vampire wants a bite out of this as well.  If your bonus takes you above $250K in earned income, you'll pay 0.9% on the excess with the Medicare surcharge on earned income.  Not only that, but the income from the bonus may expose your financial neck to the new 39.6% tax rate and subject your investment investment income to the 3.8% Medicare tax.

How can you wave a financial cross or eat enough garlic to avoid the vicious bites of the new law?  First, pay close attention to the timing of your income.  Spread your income out over multiple years, if possible.

If you are selling a property for a substantial gain, consider selling other assets, where you may have unrealized losses.  If you're holding on to a worthless stock, consider taking the loss in the same tax year as the property sale gain.

Offsetting the two allows you to get more than just a $3K deduction in the current year for a lone stock loss.  You can potentially offset all of the stock loss against the gain from the property sale.   By reducing the net gain, you reduce or eliminate the chance of getting bitten by the 3.8% Medicare surcharge, and you keep the vampire from feeding on your itemized deductions as well.

When considering a year end bonus, look at both the corporate tax rate and your effective personal tax rate after the bonus.  If the corporation is paying 34% and you have no plans to distribute dividends, you may find that not taking the bonus reduces your total tax bloodletting by keeping you below the 39.6% upper personal tax rate.

If you own an S corporation, reconsider your level of participation in the company.  If you receive income classified as passive from the company, you'll get a 3.8% tax bite from the Medicare surcharge on net investment income.  Participating sufficiently to become active in the business is like blowing a breath full of garlic at the surcharge.  It will fly back to its cave and wait to feed until you have passive income.

S corporations waive the cross at the tax act vampires in another way.  Consider an S corporation election for your business if you currently operate as a sole proprietorship or a partnership.  If you actively participate in an S corporation, only your wage income is subject to the 0.9% Medicare tax.  With a sole proprietorship or partnership, all of your profits are potentially subject to the 0.9% Medicare tax.  Dividends from active participation in S corporations are also not considered investment income for the 3.8% tax on net investment income.  S corporations are your Van Helsing, chasing away the new tax act vampires almost entirely.

Tax planning is more crucial than at any time since Ronald Reagan was President.  Eyeballing your 2013 situation against 2012 won't do.  The tax vampires will visit most affluent small business owners in 2013.  But with a little planning, they won't bleed you dry.

Thanks for reading!  As always, for real tax and accounting advice, please visit our main S&K web site at www.skcpas.com.  Also, please like the "How to Screw Up Your Small Business" Facebook page.

Until next time, let's do it to them before they do it to us.

Buying a Business - Making an Offer, Part I

If you haven't read my previous post on break even analysis, please read it before reading this one.  It teaches determining whether you are going to make an offer to purchase a particular business.  In this post, you'll learn about putting together your offer.

You have a few decisions to make when putting together an offer to purchase a business.  First is whether to buy the assets of your target business or the business entity itself.  This is a critical decision.

If you are buying the business entity, you are buying all of the assets and all of the liabilities, known and unknown, of your target business.  If your target business is a corporation, you are buying the stock of the business.  If the business is an LLC, you are buying the actual LLC.

At first, you might wonder, "Who in his right mind would take on the possibility of unknown liabilities?"  Sometimes, however, if makes perfect sense to buy the entity, and you can mitigate the possibility of getting stuck with unwelcome surprises.

If you seek a federal government contracting company with existing contracts, buying the entity is pretty much the only choice.  Federal contracts are not assignable.  To get the contracts, you have to buy the entity.  You can't purchase the contract as a separate asset.

You do not, however, have to buy a business entity to get a valuable existing business name.  The name is a separate, valuable asset that can be purchased.

When you purchase the assets of a company, you get to pick and choose exactly what you are buying.  You can, for instance, buy the customers, inventory, and hard assets of a company without buying the accounts receivable.  You can leave those with the existing owner to collect.  If the receivables are bad, that is the previous owner's problem.  You don't have to take any of the liabilities at all.  However, if you take the receivables, the existing owner will probably insist that you take the payables that produced the receivables.  But, all of this is subject to negotiation.

Let's look at the tax differences between purchasing the business entity versus purchasing the business assets.  When you buy the entity, you get no immediate tax deduction.  Your purchase is like buying Ford Motor Company stock.  If and when you sell the stock in either Ford or your new business, you'll get capital gains tax treatment on the sale.  If fact, your seller gets this treatment as well if you buy the entity.  Sellers prefer to sell their entities for this reason.  They get lower tax bills on their sales.

When you purchase the assets of a business, each type of asset has a separate tax treatment.  For the hard assets, such as equipment, vehicles, and furniture, you get a depreciation deduction.  For inventory, you get a deduction when you sell it.  Thus, purchasing assets is typically a better tax deal for a buyer even before you consider that you don't have to risk getting unknown liabilities.

If the seller wants an entity sale, but a buyer wants an asset sale, what factors determine which happens?  To capitalize on the tax advantage of an entity sale, most sellers will accept a slightly lower price for an entity sale.

A buyer can mitigate the potential danger of unknown liabilities by setting aside some of the purchase price in an escrow account.  That amount typically runs between 10% and 25% of the purchase price.  The money is released after a period of time sufficient to determine that no unknown liabilities have arisen, typically three years.

So don't completely discount the idea of purchasing the business entity, but be aware that the escrow account ensures you'll still be dealing with the previous owner until the escrow money is disbursed.  The seller and the business aren't yet completely divorced during that time period, and like an ex-wife, he'll be hanging around to make certain you give him his money.

Almost all small business sales are done as asset sales, because they are less risky for the buyer from a liability standpoint and provide for a clean split from the previous owner.

If you decide to make an offer for a business in the form of an asset purchase, you next have to determine what assets you are buying.  For small businesses, the seller typically keeps the cash, accounts receivable, and all liabilities.  The buyer gets the business name, customers, hard assets, inventory, and can choose whether to accept an existing lease.  The seller also normally agrees not to compete with you for a period of time within a specified mileage range of the business.

While you decide which assets you want to buy, you absolutely need an attorney to write the formal offer you will present.  Do not allow the seller's business broker to write YOUR offer.  As with real estate, the broker represents the seller's interests, not yours.  Most broker written boilerplate documents also have lots of legal issues.  It's your offer.  Get your representative to write it.  Paying an attorney now is way cheaper than paying one later to unwind a poorly written document.  I know from painful personal experience.

My next post will cover determining how much to offer for your target business.

As always, thanks for reading!  Your comments are appreciated and helpful to others reading the posts.  For real tax and accounting advice, please visit the main S&K web site at www.skcpas.com.  Also, please like the "How to Screw up Your Small Business" Facebook page.  I post business tips there several times daily.

Until next time, let's do it to them before they do it to us.

Using Commercial Real Estate as a Supplemental Retirement Plan

Friends, Redskins, countrymen, lend me your ear.  I come to praise Rex Grossman, not bury him.  Which is odd, since I have blamed him for everything from the increase in DC suicides to congressional gridlock.  The NSA has a secret surveillance program to figure out where he's throwing half the time.  Rex is the best third string quarterback in the NFL.  He is Bret Favre, without the talent, Peyton Manning, without the brains, Tom Brady, without the smokin' hot supermodel wife.   But, he is better than Pat White.

Pat White is the rule to which RGIII is the exception.  White is the rule that running quarterbacks can't throw.  Have you seen him throw to the right side of the field?  Not and complete a pass to someone wearing burgundy and gold.  So, I raise my glass in a toast to Rex Grossman.  May he forever stay on the Redskins sideline holding a clipboard.

Here's what I'm not talking about when I advise using commercial real estate as a supplemental retirement plan.  I am not talking about Rich Dad, Poor Dad nonsense.  I am not talking about buying real estate for no money down and flipping it in six months, thus becoming fabulously wealthy.  That won't happen.  You'll just go broke.  You're not that smart.  I'm not either.

I am also not talking about buying commercial real estate with your IRA money.  You have to be pretty stupid to do that.  It gives up the main tax advantage in owning real estate, the lower capital gains rate when you sell it.  If you put property into a qualified retirement plan, you don't pay taxes when you sell the property, but you pay ordinary income taxes when you take the money out of the plan.  Stupid - really stupid.

I am talking about buying space from which you will operate your business.  If your business doesn't require office or warehouse space, please go back to your porn site.  This post isn't for you.  There are three great reasons to buy commercial real estate for your business operations.

First, you are paying rent already to somebody.  You might as well pay it to yourself. This is the primary reason we bought our office space.  At the end of a five year lease, our monthly rent doubled, just because we needed to lease office space in a tight market.  When we bought our office space, we forever ended rent increases.  For the first few years, making the mortgage payment was difficult.  However, the payment was never going to increase again.  Our rent, in the form of the mortgage payment, was never going to increase, let alone double, again.

Second,  over a period of ten or twenty years, your commercial real estate investment will increase in value, and you get capital gains treatment when you sell it.  If you intend to be in business for less than ten years, again go back to your porn site.  Commercial real estate, in the short term, is a wild ride best avoided.  Prices can move down or up twenty percent in a year.  However, if time allows you to sit out the price swings, commercial real estate is a great investment.  The eventual appreciation is a great tax advantaged supplement to other pension plans.

The third reason to own commercial real estate for your business is that the rent is an excellent way to get money out of your S or C corporation without suffering the tax disadvantages of dividends or salaries.  You also have wide latitude in determining a fair rent to pay yourself.

How can you afford to buy office or warehouse space?  The SBA loves making real estate loans.  They love hard assets.  You'll have to operate your business there, though.  The SBA doesn't loan for investment properties.  Pretty much nobody does anymore unless you have forty percent down.  For your purchase, you'll likely need ten percent down.  The place to look for an SBA loan is a local bank specializing in small business lending.  Look for a bank that makes a lot of these loans.  You don't need an amateur banker, who is more comfortable with home mortgages.  Commercial real estate loans are a whole different animal.

Here's a hint on owning the real estate.  Create a limited liability company (LLC) to own the office or warehouse space.  Then make the LLC the landlord for your business.  This separates the building from your business for liability purposes.  If your main business goes bankrupt, you may get to keep the building since it is in a separate entity.  No guarantees there.  Check with your lawyer.  You can also easily sell the business, or real estate, separately from the other.

Commercial real estate can be a valuable part of a comprehensive retirement plan.  I drank the Kool Aid myself.  But have realistic expectations.  It is a part of the plan, not the whole plan.

Thanks for reading.  For real tax and accounting advice, please visit the main S&K web site at www.skcpas.com.  Also, please like the "How to Screw Up Your Small Business" Facebook page.  I post snarky tips there three or four times daily.

Until next time, let's do it to them before they do it to us.

Die Without a Buy-Sell Agreement

I just returned from a week of sightseeing in Boston.  Reading a book on Thomas Jefferson ignited my interest in the pre and post Revolutionary war periods. We did all of the normal touristy stuff.  At the end of our week, we took a Ghosts & Ghouls tour of Boston burial grounds.  As part of the tour I was hanged at Boston Commons.  Please send money to my not so mourning family.  Then the tour guides married me off to a serial killer.  She killed her first four husbands before being slain by her fifth.  It was a tough week.

September 2012 was a tough month for me.  Actually, it wasn't so much tough on me but on my clients.  Four died in one month.  Our staff joked that being my client was a terminal disease.  Three of these clients had their affairs well in order.  But one didn't.  He owned a business with a partner.  He died without a buy-sell agreement or an operating agreement.

Fred and Al owned an IT business that served the federal government.  They provided fail over services for government agencies.  If you had computer operations in say... the World Trade Center, and someone flew a plane into the building destroying your IT facilities, Fred and Al made certain your operations continued as usual.  You can probably understand that Uncle Sam had quite an interest in their services.

Fred and Al were both in their mid-forties and in good health.  Then Fred got run over by a truck, literally.  He died instantly.  Fred and Al had neither a buy-sell agreement nor an operating agreement.  What happens when your business partner dies, and you don't have the legal documents to ensure an orderly transfer of the business?

You end up with unwanted partners, and they aren't usually the silent type.  Al was contacted by a personal injury attorney representing the two daughters from Fred's first marriage.  Al barely knew the daughters existed.  Since, there were no legal agreements regarding what happened to the business upon Fred's death, the attorney volunteered to draft an operating agreement for the business installing the two daughters as Al's new partners.

Here's the problem with allowing a personal injury attorney to write an operating agreement in these circumstances.....  Personal injury attorneys don't know a damn thing about estate law, at least this moron didn't.  Fred's daughters were not the rightful owners of Fred's share of the business even though they were his heirs.  In Virginia, Fred's estate owned Fred's share of the business.  The attorney was busy writing an invalid agreement.

I referred Al to an estate attorney, who began the process of probate for Fred's estate, working with Fred's second wife to close out the estate.  In Virginia, counties administer the probate process.  Periodically, the estate executor files an asset inventory and reports on the progress in winding up the estate.  Besides the legal fees, the county requires substantial probate fees based on the value of the estate.
Fred's share of the business was his primary asset.  So the estate engaged me to provide a valuation of Fred's share on the date of his death.  Al, and the estate attorney, hoped to use this valuation to settle the estate and buy out any claim on the business from the daughters.  Hoped is the key word here.

If you are caught in Al's situation, you can be certain of one thing.  The heirs of your business partner will smell the pot of gold.  They are thinking millions of dollars for their share even if they peed in his porridge while he was alive.  It's party time, baby.  Fred's daughters were no different.

Fred and Al had a nice business, but it was really just two well paying jobs.  They provided all of the services personally, relying on their combined forty years of engineering expertise creating fail over systems.  That doesn't make for a valuable business.  For Al to continue the business, he needed to hire someone with similar expertise.  These people aren't cheap.  In fact, it was going to cost more to replace Fred than Fred's salary.

Fred and Al were very valuable computer engineers, but the business itself was worth pretty much nothing since the pool of potential buyers was almost nonexistent due to the technical qualifications required of a new owner.  I valued the business at just the cash on hand and the receivables at the date of Fred's death.  Fred's half of that was about $100K, hardly the millions his daughters envisioned.

Are you surprised that they weren't happy with me?  Al was faced with tens of thousands of dollars in legal fees, not to mention the business disruption.  He offered the daughters the opportunity to pick a business valuator of their choice.  But, that would cost them money.  They were content to threaten legal action and delay the closing of the estate.  The county was after the estate to close and continued to impose more fees.  The business was being ignored.

In frustration over the lack of progress getting the business out of the estate, Al hired a litigation attorney.  Al's attorney asked the daughters to submit what they thought the business was worth telling them that Al would either buy it from the estate for that price or sell his share for that price.  They would then be obligated to buy Al's share at his option.  Of course, they refused.  They had no money, but they had plenty of attitude.

Al's attorney then told the daughters that Al was resigning from the business.  Since there was no operating agreement, Al was free to withdraw from the business and form his own new company.  Of course, he couldn't take any existing contracts with him, but those contracts were worthless without him.  The daughters would never be able to manage the existing contracts, and the business would fold.  Then Al could bid to get the contracts back.

The daughters' attorney called for a mediation meeting and the daughters settled for almost the exact value I had calculated.  Al had his company back after spending $20K or so, not exactly a happy ending, but a satisfactory one in the end.

Dying without buy-sell and operating agreements is malpractice for a business owner.  You are ensuring heartache for your family.  Of course, if you hate your partners, spouse, and family, go for it.

Thanks for reading!  For real tax and accounting advice, please visit the main S&K web site at www.skcpas.com.  Also, please like the "How to Screw Up Your Small Business" Facebook page.

Until next time, let's do it to them before they do it to us.

Fire Your CPA

What's the difference between a CPA and a prostitute?  People willingly pay the prostitute.  CPA's are like hockey coaches.  We are hired to be fired.  Experienced CPA's understand this.  Just as a hockey team quits listening to its coach, a client will quit listening and responding to a CPA.  Sometimes this happens in ten years.  Sometimes it happens in two.  Good CPA's won't stand in the way of your switch.  We're on the other side a lot as well.

There are two good reasons to fire your CPA.  First, if you're not getting what you're paying for.  Second, if you're not getting services you're willing to pay for.  Note that both of these reasons are about payment.

If you want good service from your CPA, expect to pay...and pay without incessant griping.  Complete this sentence.  If great clients get great service and good clients get good service, bad clients get...

Here's the definition of a great client for a CPA: someone who pays on time without griping and meets client obligations on a timely basis.  That means, if I have to hunt you down and beat your ass to get a question answered for a tax return, you aren't a great client.  You're creating your own bad outcome.

My most successful client gets great service from me by paying on time and in full.  He also pushed me to increase my rate to near what he pays his attorney.  He didn't do this out of the goodness in his heart.  He expects my full attention when he wants it.  He gets it.

Imagine this scenario.  He calls and you call at 6 PM on a Friday night.  Both of you need something by 7 PM.  He pays top rate and on time.  You gripe about my rate and pay when you damn well feel like it.  Guess whose job gets done.  Go ahead, guess...

However, if you pay on time, have reasonable expectations and you aren't getting what you pay for, fire your CPA.  If you bring in your personal tax information in late February, answer your CPA's questions timely, and still your tax returns aren't done in mid-July, fire the bum.  If he doesn't return your phone calls and e-mail messages, you're not a valued client to him, despite his protestations when you tell him to kiss your ass.

Here's what doesn't count as your CPA's fault.  A few years ago, my first personal tax client came in January.  Her return was the last to be completed before April 15th.  Why?  When she came in, she had about ten percent of her tax documents.  I sent her a questions list on early February.

In April she complained that her returns weren't done yet despite coming in early.  She wanted to know why they weren't done.  The answer was that she's a dumb ass.  She wasn't functioning on a normal adult level.

"Oh Frank," you say, "Why didn't you follow up with her?"

We have a wonderful project management system that sent her e-mail reminders every five days.  Maybe sometime between early February and early April, she could have been bothered to play her part in the great tax return drama that closes every April 15th.  This wasn't my fault in any way shape or form.  This isn't an isolated case either.  Some variation of this occurs thirty times every tax season.  Repeat after me, "Bad clients get bad..."

FInally, if your CPA doesn't offer the services you need, move on to someone else.  A 21st century CPA offers services besides income tax preparation.  If he closes down on midnight April 15th never to be heard from again until next tax season, he's headed towards retirement.

At the very least, most affluent clients need tax and retirement planning.  We are busy all year with tax and retirement planning.  I have trouble scheduling vacation.  We meet (or meet virtually) with almost all of our business clients between September and December.  We prepare detailed tax projections that frequently include multiple scenarios and multiple years.  The tax biz is a year 'round biz.  If your CPA isn't a year 'round dude, time to find one who is.  Operators are standing by.

Thanks for reading.  As always, for real tax and accounting advice, please visit the main S&K web site at www.skcpas.com.  Also, please like the "How to Screw UpYour Small Business" Facebook page.  I post snarky tidbits there daily.

Until next time, let's do it to them before they do it to us.

Rent Out Your House

Who says Commies don't get capitalism?  This week Russian punk rock group, Pussy Riot, was back in the news.  They may not be good at music, but they are great at branding.  If they were named Ruptured Spleen Riot, would we have heard about them?

So you want to move to a bigger house but can't, because your current house is so far underwater the zip code was changed to Atlantis.  How will you ever manage to fit four wives, ten children, and fifteen cats into your three bedroom townhouse?  You're in luck, because I have the answer.  It might not be a good answer, but you aren't paying anything for this advice.  So you'll get what you pay for.

There are three things to know about taxes on rentals before you advertise your house on Craigslist: 1. How your rental will affect your tax situation, 2. What you can deduct, and 3. How you report the income and expense on your tax returns.  Let's start out with #1.

You might reasonably think renting out your house puts you in the rental business, not really from an IRS perspective.  Unless you are a real estate professional, meaning a real estate agent or involved in a real estate trade, your rental is considered a passive activity.  With a normal trade or business, if you make a profit, you pay taxes on the profit.  If you incur a loss, you can deduct the loss against other income such as wages.  This isn't true with rental real estate.

With rental real estate, you pay taxes on any profit you earn, but you do not get to deduct any losses you suffer unless your adjusted gross income is less than $100K.  If your income is less than $100K, you can deduct up to $25K in rental losses.  If your income is between $100K and $150K, you get a prorated portion of the $25K.  If your income exceeds $150K, you get no immediate deduction at all.

You don't lose any rental losses that you can't immediately deduct.  You carry the losses forward to future years until you either have a rental profit, which you can then offset dollar for dollar, or until you sell the house.  Then you can deduct any remaining losses that you have not been able to deduct.

If you make more than $150K and a buddy tells you to invest in rental real estate for the tax break, he is full of......full of something foul and smelly.  Rental real estate can be a good investment, but not for an immediate tax break.  It can be good for price appreciation potential, which can be taxed at the lower capital gains tax breaks.  Real estate can be a great part of a retirement plan, just don't put it in an IRA.  You'll lose the capital gains tax rate that way.

If you aren't planning on holding a property for five years or more, your investment will likely be a bad deal.  Yes, I know about flippers, not the amphibian kind, the stupid kind, who believe they can outguess the real estate market.  I prepare their tax returns.  Here's how they go:  small gain on the first deal, small gain on the second deal, then total loss on the third.  Losers don't brag, liars do, however.  You've been warned.

You might also ask, "Frank, how do I become a real estate professional?  That way I can deduct my losses regardless of my income."

There are two requirements to be considered a real estate professional.  First, you must have at least 750 hours in real estate activities.  That seems simple enough to meet.  However, the second requirement is that more than half of your work hours must be spent in a real estate related profession or trade.  That's the tough one.  If you have W-2 income from a non-real estate job, you probably can't qualify.

"But Frank, how will the IRS know whether I spend more than half my time in real estate?"

Here's how to find out. Try deducting a rental loss when you have substantial W-2 wage income.  You will likely get a personal invitation to your local IRS office.  You'll need a log of your hours to prove more than half your time was in real estate.  No log, no deduction.

Think broadly about the potential expenses you may be able to deduct against your rental income.  Let's start with this partial list:
a. Mortgage interest
b. Real estate taxes
c. Utilities
d.  HOA dues
e. Repairs
f. Depreciation
g.  Travel to the rental
h. Professional fees
i.  Landscaping and maintenance
j. Management fees and rental commissions
h.  Cleaning supplies

For depreciation, you depreciate the building, not the land, using the straight line method over 27.5 years.  Why 27.5 years?  Why not?  Tax law doesn't have to make sense.  How do you separate the building value from the land value?  Look at your tax appraisal.  That will give you the proportion of the total property value that is building.  You then apply that percentage to either your original cost of the property or the market value when you make the property available for rental.  You use the lower of the two values.  You do include settlement costs in the original purchase price.

You also get depreciation deductions for improvements and major replacements.  Improvements attached to the structure of the building are depreciated over 27.5 years.  Replacement appliances are depreciated over five years.  IRS publication 527 covers expenses related to residential rental real estate.  You can get it at www.irs.gov.  It's great bathroom reading, guaranteed to cure constipation.

There are three primary schedules you'll use to report your rental activity on your personal tax returns, schedule E, form 4562, and form 8582.  Schedule E is the main form where you list the rental income and expenses.  Form 4562 is the form where you calculate depreciation.  Form 8582 is where you determine how much of your rental loss is deductible and how much carries forward to future years.  You can also get these forms at www.irs.gov.  This site's porn for tax preparers.  Sad, but true.  At least it's free.

Good luck in renting out your house.  You'll need it.  The tax complications are the least of your worries.  You'll face idiot tenants.  You'll get to pay moron contractors to repair your property.  All of this is pure joy.  Trust that I know this from experience.  We just received a contract to sell our rental property.  If I had to make a choice between that sales contract and sex with Jennifer Aniston.....well it's a close call.

Thanks fro reading!  As always for real tax and accounting advice, visit the main S&K web site at www.skcpas.com.  Also, please like the "How to Screw Up Your Small Business" Facebook page.  I post snarky and helpful business advice several times each day.

Until next time, let's do it to them before they do it to us.

The Five Stages of Grief in an IRS Audit

Death and taxes share more than just a cliche'd phrase about inevitability.  They share a common process when it comes to an IRS audit, the five stages of grief.  Few events cause as much grief as an IRS audit.  How you handle the five stages determines your eventual audit outcome as surely as the quality of your documentation.

The first stage is denial.  "This isn't happening to me."  "There must be some mistake."  Denial often manifests itself through procrastination.  Some people don't open the IRS envelope with the audit notice.  Some open the notice, but never respond to the scheduling information.  They lose precious weeks of preparation.  If you need to produce bank statements, you can't make the bank respond overnight.  You can't find a competent professional to represent you overnight.

Denial, in the form of procrastination, is the first step to a bad audit outcome.  When you get the dreaded IRS notice announcing your audit, gather all of your tax records for the year being audited, and immediately contact a CPA or attorney to represent you.  Your professional representative will schedule the audit.  Audits are about credibility, and nothing establishes credibility with the IRS like a professional representative.

The second stage is anger.  This is the "How dare they?  I'm a God fearing, honest American.  They have no right to audit me."  stage.  An audit is a legal proceeding.  You are legally obligated to participate.  There is an alternative minimum tax but no alternative minimum audit.

Anger, during an audit, never works in your favor.  IRS examiners face angry people every day.  You and I might have trouble handling personal rejection, but IRS employees face it every day.  They develop immunity, or they don't last long.  Remember, audits are all about credibility.  Anger costs you credibility.  An auditor, who likes you, might give you the benefit of the doubt in a gray area of tax law or documentation.

The third stage is bargaining.  "If I just tell the auditor..... he has no choice but to take my word."  Yes, he has a choice.  As much as audits are about credibility, they are about documentation.  The auditor has a checklist for every issue selected for audit.  If he's auditing real estate taxes, you need mortgage interest statements and mortgage documents from your bank.  Nothing else will work.  Your aim in the audit is to help the auditor complete his checklist.  If he feels you aren't cooperating, he can increase the scope of the examination.  If you're caught in a lie, he can place additional years under audit.  Again, your credibility determines your outcome.

In one audit, one of my clients was caught in a lie in the first half hour.  What looked to be a half day audit covering one year turned into a three month nightmare covering three years of not just his personal tax returns but also his corporate tax returns.

The fourth stage is depression.  "This audit will never end."  "I never have enough documentation for the auditor."  "He's not being fair."  "I can't possibly pay the taxes he is going to assess."  You will get through the audit.  I have never seen one last forever.  The IRS takes a cost benefit approach to audits.  An audit is done when the auditor believes that any additional efforts will yield little in additional taxes.

Combat your depression by helping he auditor complete his checklist.  You don't have to agree with his conclusions.  That's not your aim here.  Your aim is to get him through his procedures and to an assessment.  There are lots of inexperienced auditors at the IRS.  they make a lot of factual mistakes.  Arguing with the field auditor wastes your time and doesn't get you any closer to the end of the audit.

Once you have the tax assessment, you get to argue your case before a more experienced supervisor.  Many times, I have been able to knock out almost all of the field auditor's conclusions in a telephone call with the supervisor.  They have the experience to know what they'll lose in a formal appeal or in tax court.

The final stage is acceptance.  If you made mistakes in your tax returns, or can't support the deductions you claimed, you will have to pay additional taxes.  If the assessment is large, the IRS will work with you to arrange a payment plan.  Of course, I don't recommend handling the payment negotiation or any part of the audit yourself.  An audit is an adversarial procedure.  The auditor represents the interests of the IRS, not you.  You need someone knowledgeable representing your interests or you may face payments you can't afford.  That's bad not only for you but the IRS.  If you're broke, they can't collect their taxes.

If you legitimately owe more taxes, sometimes the best thing your representative can do for you is negotiate down any penalties.  If you're assessed an accuracy related penalty, a good representative can make a case that you acted in good faith and shouldn't face penalties.  If you and your representative have established credibility with the auditor, you'll get the benefit of the doubt here.  The auditor has a lot of discretion with this penalty.  Removing or reducing it is your reward for being a decent human being during the process.

Thanks for reading!  For real tax and accounting advice, visit the main S&K web site at www.skcpas.com.  Also please like the "How to Screw up Your Small Business" Facebook page.  I post there several times a day.

Until next time, let's do it to them before they do it to us.

How to Get Your Company Tax Returns Done Quickly and Painlessly

Some of you have expressed concern about the time table for my recovery from my hamstring strain.  Or maybe that was concern for RGIII's recovery from knee surgery.  I also hold Dr. Andrews responsible for my injury.  The last game of the year, he had every opportunity to tell me not to run to the refrigerator for the last beer of the regular season.  I was in no physical condition to hurdle the dog and elude my mother-in-law as I raced against the game clock.  I also hold Mike Shanahan responsible.  He had a time out available.  I'm keeping that in mind while I consider my free agent beer drinking options.  At least I didn't spill the beer.

There are a few easy ways to make certain your CPA makes the March 15th corporate tax deadline.  First, understand that your company's tax return is not the only return your CPA is preparing during tax season.  You deserve good, but not exclusive service.  If you have a CPA, who's not busy during tax season, you have a newbie or somebody who doesn't have much business.  That's bad.  I know what my level of expertise was thirty years ago.  Today, I wouldn't hire the thirty year younger me.  If a CPA has few clients, the business world has expressed its opinion on his expertise.

The second thing to keep in mind if you want your corporate tax returns prepared by the deadline is that not all of a CPA's corporate clients can show up on March 14th and expect to get their corporate returns done by the deadline.  In fact, they can't all show up on March 1st.  Most established firms have deadlines the last week in February.  Some cut off on February 15th.

If your CPA's deadline is February 28th and you get your books to him right before that date, you will not get the attention and service you'll get in early February.  In January and early February, your CPA has the time to consider different tax treatments and what if scenarios like pension contributions and switching your accounting basis.  He can spend time on research.  By the end of February, his focus is on getting returns out the door.  If you want a meeting to discuss some aspect of your corporate returns, forget about it.  There just isn't time in March.

One last item to consider regarding your CPA is that if your return isn't complete by the March 15th deadline, it likely won't be completed until after the April 15th personal tax deadline.  On March 16th, CPA firms switch from focusing on corporate tax returns to personal tax returns and the April 15th deadline.  From March 16th through the end of March, I am scheduled for ten to fifteen personal tax appointments every week day.  That doesn't leave time for corporate tax return preparation.

The switch to personal tax return preparation is really bad news for S corporation owners.  It means that if you miss the deadline for your corporate tax returns, you will likely miss the personal tax deadline as well.  The difference between having your books ready in late February and early March is the difference between having your personal tax returns done by March or waiting until May or June.  That should motivate you to motivate your bookkeeper.

Your books should be closed for the prior year by the first week in February.  Publicly held companies are required to have financial information to the S.E.C. within a month.  If billion dollar companies can do it, you can too.

Step one in preparing for your 2013 year end starts now. Your bookkeeper doesn't have to wait until next January to get serious about getting caught up.  Establish a standard monthly schedule of having the prior month's books completed by the 15th of the next month.  Require your bookkeeper to produce monthly balance sheets and income statements by that time each month.

For each year, twelve months of bookkeeping has to be done.  There is no reason to wait until the last quarter of the year to get started.  There are only two possible reasons your bookkeeper can't meet this schedule.  One, she may need more staffing resources.  Second, you have the wrong bookkeeper.  Your CPA will be happy to help you make this determination in the summer, before you fall behind.

There are two common reasons bookkeepers fall behind.  First, they don't work diligently enough in the first three quarters of the year.  Don't ask me what they do for the first nine months of the year, but the evidence suggests not much in a lot of cases.

Second, bookkeepers take time off during November, December, and January.  The answer to this is "no."  The bookkeeping profession, like the CPA profession, has periods where vacations aren't allowed.  Your bookkeeper will tell you it stinks that she can't have extra time off during Thanksgiving and Christmas to visit her dying Aunt Irma, but she chose her profession.  You didn't choose for her.  Don't pull the plug on Aunt Irma until the books are closed for the year.  She'll wait.  What else does she have to look forward to?

Wil Ferrell's character in the movie "Old School" screams for his meatloaf and comments about his mother in the kitchen, "I don't know what she does back there."  If you feel that way about your bookkeeper, it's time for a change.

Thanks for reading!  For real tax and accounting advice, please visit the main S&K web site at www.skcpas.com.  Also, please like the "How to Screw Up Your Small Business" Facebook page.  I post tips and snarkiness a couple times per day.

Settle Your IRS Debt for Pennies on the Dollar - Part II

Some not very nice people have pointed out some alleged similarities between the imaginary girlfriend of a Notre Dame football player and my relationship with Jennifer Aniston.  Those people are mean spirited and factually incorrect.  My beloved Jen exists.  It is our relationship that is imaginary.

To assuage my injured ego, I created a religious support group for victims of cyber-bullying, like me, called Stop Teasing Us People in Denial (S.T.U.P.I.D.).  We even have a holy scripture called The Book of Moron.  The idea for the group came to me in a vision, after a dozen Yuenglings.  Our prophet, Dr. Phil, revealed that our destiny as S.T.U.P.I.D. people is to join Tom Cruise on an alien spaceship.  It's either that or the looney bin.

Here is an example of how not to negotiate a settlement with the I.R.S.  Ann engaged me to represent her in settling a tax debt.  She had not filed tax returns for a number of years.  The I.R.S. won't negotiate a payment plan with you until you have filed all your tax returns, and they know the total magnitude of your liability.  Agreeing to a plan makes no sense if you subsequently file a tax return with another big tax balance due.  So, first, we prepared and filed her overdue tax returns.

As a result, Ann owed about $50K in income taxes.  She then engaged me to negotiate a payment plan to settle her tax liability.  I spoke with the I.R.S. a few times, and we were close to a monthly installment agreement.  When you have a tax balance of that size, however, the I.R.S. wants some paperwork proving that there are no assets that can be used to pay the liability in full immediately.  For non-business owners, this is a form 433A.  The form is a personal financial statement listing your assets, liabilities, and sources of income.

When we were almost finished with the form, Ann mentioned that she had just inherited $40K and a house from a well to do relative.  She had given me none of this information before.  Of course, this was good news to me.  We really didn't need a long term installment agreement with the I.R.S.  She could almost pay off the tax debt with the inherited cash. I was ready to call the I.R.S. and tell them Ann could pay almost all of the balance due immediately and the rest shortly by either selling the inherited house or refinancing it.

That wasn't Ann's plan, however.  She didn't want the I.R.S. to know about her good fortune.  In fact, she wanted to make an offer in compromise to pay less than her full tax balance.  If you read my last post, you know why that never had a chance, not to mention the lying necessary.  Because I value my CPA license more than I valued her business, I withdrew from representing her.  She has to pay her taxes in full just like the rest of us.  I won't be a party to tax fraud.

The right way to settle an I.R.S. debt starts with knowing three dollar amounts: $10,000, $25,000, and $50,000.  These amounts set thresholds that determine your options for reaching an agreement with the I.R.S.

If you owe less than $10,000, reaching an agreement with the I.R.S. is simple and easy.  You don't even have to talk to them.  Download form 9465 from www.irs.gov and propose to pay a monthly amount.  Here are some guidelines to increase your chance of success.  First, multiply your tax balance by 120% to get a really rough idea of your tax liability after penalties and interest.

The I.R.S. will normally accept any payment offer that gets your balance due paid in twenty-four months or less.  So take your balance due plus penalties, divide by twenty-four and make the resulting amount your offer.  If you don't believe you can afford that monthly amount, recalculate the amount over thirty-six months.  Keep in mind, however, that this amount is significantly less likely to be accepted immediately.  You may get a letter of rejection.  Then you must call them and show them some financial amounts amounts proving that you can't pay within twenty-four months.

The next threshold is for tax balances due between $10,000 and $25,000.  You can either file form 9465 or complete an installment agreement request form online at www.irs.gov.  However, acceptance of your offer is not automatic and undergoes a little more scrutiny.  You can propose up to seventy-two months to pay your liability, but my experience is that you will likely be rejected if you propose more than sixty-months to pay.  Then you have to call and prove your need for seventy-two months.

The third threshold is for balances due between $25,000 and $50,000.  You can compete a slightly different form, form 9465-FS.  You can also use the online system from the last paragraph.  For balances due of this size, you have to provide some summary financial information.  The I.R.S. can again accept up to seventy-two months for a payment agreement.  With a larger tax balance due, they are more likely to accept a longer agreement.

The past threshold is for balances due greater than $50,000.  Getting a payment arrangement for amounts this large requires giving the I.R.S. extensive financial information.  If you owe this much, consult an attorney.  Negotiating with the I.R.S. for large balances due isn't a do it yourself activity.  Nor is it much fun.

Once you have given the I.R.S. all of your financial and bank account information, they have all the information necessary to seize all of your money and assets.  You need someone, an attorney, who can top the process in court, if necessary.  You may need to seriously consider bankruptcy.  As I mentioned last week, the I.R.S. really doesn't care that your kids are in an expensive private college or that you have a million dollar mortgage.  They'll give you a regionally adjusted living allowance and expect you to pay everything above that to them.

Here is the profile of the average person I see get seriously in trouble with the I.R.S.  He / she is normally self-employed with a gross income, before expenses, of $50K to $100K.  He / she struggles to pay the mortgage and has trouble keeping up with other bills.  Quite often, he / she owes substantial credit card debt.  That leaves no money to pay taxes.  Frequently, he / she doesn't file tax returns for three or four years.

Over the three or four years of unfiled returns,  he / she runs up tax balances of $5K to $8K annually in self-employment taxes as well as normal federal and state income taxes.  Then the I.R.S. starts sending urgent notices demanding the filing of the tax returns, and all of the sudden he / she owes $30K to $60K in unpaid taxes.  These are difficult cases to resolve since the people typically have next to nothing available to pay after basic living expenses.

Self employment is a rotten tax deal until you start making at least $125K after expenses.  If you make less than that, you are probably paying 40% of your profit in self employment, federal, and state taxes.  A steady job starts to look pretty good.

There apparently people more gullible than Notre Dame football players - Washington Post reporters.  Yesterday's Post featured an article on a man, who has created a web site devoted to protecting second amendment rights.  Early in the article, the reporter mentions that the man had just sold a web site on cars.  Now, he was suddenly passionate about gun ownership and the second amendment.  He became so passionate, he created a web site.  Hmmmmmm.

Don't you suspect that this guy is more interested in creating and selling this site than the second amendment?  The Post has provided tens of thousands of dollars in free advertising for him.  He is brilliant.  The reporter - not so much.

Thanks for reading.  For real tax and accounting advice, please like the "Stitely & Karstetter" Facebook page as well as the "How To Screw Up Your Small Business" Facebook page, where I post daily business tips.  Until next time, let's do it to them before they do it to us.

Settle Your IRS Debt for Pennies on the Dollar

I dedicate this blog to the memory of my dead hamster Lulu.  Her full name was Honolulu Maui.  She was my Hawaiian fuzzy friend.  From the moment she friended me on Facebook, we felt an instant connection.  Although I never caressed her furry body in my palms, she was my soul mate.  I longed to see her nibble on a carrot.

For a few moments, like when she asked for my bank account information, I thought that maybe she didn't really exist.  When she explained how her Skype account had been cut off, I used my Paypal account to send her the necessary $10K to get it turned back on.  Her Skype never did work due to a vicious German Shepherd, who bit through the cable to her camera.

Lulu died in a tragic car accident in September.  Her Volkswagen Beetle was crushed underneath an eighteen wheeler carrying dog poop.  Even though alcohol was found in her system, I do not believe her driving was impaired.  So long and farewell Lulu.  I am sending your estate $20K for the funeral.  I won't be attending her funeral because of tax season, but she knows I'll be there in spirit.

Speaking of imaginary friends, this time of year the tax resolution firms bombard us with advertisements for  new IRS programs that offer to settle your IRS debts for pennies on the dollar.  Former TV "star", Alan Thicke, stars in one ad running now on the radio.  He tells us that a brand new IRS program now gives you the chance to eliminate up to ninety percent of old tax liabilities.  What great news!

Maybe not.  First of all, there are some relatively new IRS programs, such as the Fresh Start program, but these programs won't relieve you of taxes you legitimately owe.  How can the tax resolution firms make these outlandish claims of tax freedom?

They lie - or at least they only tell a small portion of the truth.  To find out if you "qualify" for these wonderful new programs, you'll pay a $2,500 to $5,000 retainer.  Then they'll listen to your story and explain to you that you don't really qualify for the ninety percent reduction programs. But, they can negotiate an installment agreement with the IRS so that you can pay your taxes, including interest and penalties, over time.  How can they get away with doing business this way?  For the most part they don't.  These firms are always in trouble with state authorities.  Some of the owners are doing jail time now.

The other way they claim big tax liability reductions is to cite instances where a taxpayer really didn't owe the taxes in the first place.  For example, maybe you forgot to record stock sales from your brokerage statement.  The IRS computer sees this and sends you a big tax bill.  They assume you paid nothing for these stocks.  All you have to do is amend your return for both the sales proceeds and the cost of your stock purchases, and you may owe little or nothing.  Maybe you even get a refund.  I handle these situations fifty times a year.  But, I don't claim I got rid of ninety percent of your tax liability.  I know you didn't owe the taxes in the first place.

What's the real story about settling tax debts with the IRS?  First, let's look at the regulations that govern when the IRS can accept an agreement to pay back taxes for less than the full amount.  There are three reasons the IRS can accept for paying less than your full tax liability.

First,  the IRS will settle for less than your full tax liability if there is doubt as to whether you actually owe the money.  This happens when you have been audited by the IRS, and they assess additional taxes on you based a gray area of the law.  Rather than face you in tax court and potentially lose a case that could set a precedent, they'll negotiate with you.

Second, the IRS will settle for less than your full tax liability if your tax debt is not fully collectible.  Before you break out the champagne, there is a catch.  You don't get a break because you are having a rough time financially.  Not fully collectible has a very specific definition.  It means that your income and assets, after allowed living expenses, cannot pay the debt in full within ten years.  Any amount not collectible in ten years will be written off.

"Allowed living expenses" has a very specific definition as well.  You will be given an allowance for housing, vehicle expenses, food, clothing, and some other necessary items.  The allowance for housing does not include an amount sufficient to make payments on your million dollar mortgage or the payments on your Mercedes.  You get regionally adjusted amounts from a table.  The IRS doesn't really care if you have to stiff your other creditors and file for bankruptcy to live within their allowance.

The third reason the IRS will compromise your tax liability is for efficient tax administration.  Not even the IRS knows what that means, nor do I.  I have never seen this provision used.  I suspect the IRS fears a congressional backlash if they ever use this provision.

What about this thing the tax resolution firms refer to as an offer in compromise (O.I.C.)?  Keep in mind all three rules above apply to O.I.C.'s.  So don't expect to walk away from your tax bill.  The O.I.C. form walks you through the calculation for rule two above.

Here's a sobering statistic about O.I.C.'s.  The IRS accepts less than twenty percent of O.I.C.'s.  Even that is a vast overstatement.  The overwhelming majority of people, who start the O.I.C., process, never complete the process.  I have started the process for a number of clients, but I have never submitted a completed offer.  In most cases, we come to an agreement with the IRS through other programs.  However, in some instances, our client simply stopped the process when they realized that the O.I.C. process gives the IRS complete knowledge about their income and assets.  if the IRS turned down the offer, they would have all of the client's bank account information.  The IRS would be in position to immediately seize all of my client's money.  So your odds successfully submitting an O.I.C. are slim and none.
The IRS will work with you to settle your tax liability.  In my next post, I will discuss the mechanics of reaching a real world agreement with the IRS.  Expect pain.  The basic IRS collection principle is that someone, who pays his taxes late, cannot be placed in a better position than a taxpayer, who complied with his payment obligations on a timely basis.  That is just basic fairness to all of us, who meet our obligations.  Yes, you can settle your IRS debt for pennies on the dollar - 115 pennies to the dollar just like everyone else.

Next week's Superbowl has been renamed the Psychopath Bowl.  It features the Forty-niners coach, who has turned the post game handshake into a potential UFC fighting match.  He doesn't play well in the sand box with the other NFL coach children.  The Ravens feature Ray Lewis, the would be serial killer, whose limo was found with blood stains from a murder victim prior to a Superbowl a few years back.  I have no idea who to root for.

Thanks for reading.  For real tax and accounting advice, please like the "Stitely & Karstetter" Facebook page as well as the "How To Screw Up Your Small Business" Facebook page, where I post daily business tips.  Until next time, let's do it to them before they do it to us.

How the Grinch Stole Your Tax Refund

On Sunday, the Redskins backup rookie quarterback, Kirk Cousins, put up thirty-eight points on the Cleveland Browns.  Cousins was a fourth round draft pick from Michigan State, whose selection was roundly blasted by Skins fans as unnecessary and wasteful after giving up so much in draft picks to select RGIII.  Cousins has got to be singing, "How do you like me now?" after more than three hundred yards passing.

I won't say I told you so, but I told you so.  Before the beginning of the season, I posted that I was more excited about having Cousins than RGIII.  After the preseason, that seemed justified.  Yes, you might argue that I was just a little bit wrong about the importance of RGIII, but why bring up such unpleasantness at Christmas?

2012 is the strangest year for tax planning in my twenty-three years in practice.  For the first time in my memory, and my kids tell me I go back to the dinosaur era, we are advising people to pay more in taxes.  Why?  Because, the Grinch has stolen most of our tax breaks for 2013.  For this post, I will concentrate on how the Grinch is affecting your non-qualified stock options.

Non-qualified stock options are options to purchase your employer's stock at a set price for a set period of time.  I used the term, non-qualified, to refer to options that are not incentive stock options.  Yes, all options are supposed to be incentives, but the term, incentive, has a special meaning when applied to stock options.

Incentive stock options are intended to be exercised, and then you hold the resulting stock for more than one year.  Incentive options have some special tax aspects regarding alternative minimum tax and capital gains rates.  I may cover these in a future post.  The Grinch is stealing your tax benefits for these as well.

Non-qualified options are simply any options that aren't incentive options.  For instance, let's assume you have the option to buy 100 shares of your employer at $100 per share, and that you can exercise those options anytime in 2012 or 2013.  Let's also assume that the current stock price is $125 per share.  If you exercise these options and sell the stock immediately in what is known as a cashless exercise, you will have income of $25 per share or $2,500, which is the difference between the price at which you sold the stock and the exercise price.

Because the options are non-qualified, the income is considered compensation income just like any other salary and is subject to all of the normal tax withholding, including Social Security and Medicare.  The income will be recorded on your year-end W-2 tax statement as well.  If you had the choice between exercising the options in the current year or next year, normally I would advise you to choose the next year to defer taxes as long as possible.

However, 2012 is different.  The Grinch will be visiting us in 2013 and stealing many of our tax breaks we have enjoyed since 2001.  The first goodie he has stolen from under our Christmas tree is our low tax rates.  Rates are going back to 2001 levels effective January 1, 2013.  If you household income is over $200K, expect to feel some pain, maybe not gunshot wound level pain, but a dull toothache kind.

Second, the Grinch is giving us a gift we'd like to return, but he'll give us no return receipt.  There is a new .9% Medicare surcharge on earned income over $250K for married taxpayers ($200K for those smart enough to be single).  So if you exercise your non-qualified options in 2013, and your income is over the threshold either before the options income or after it, you will be subject to this new tax.

Finally, the Grinch is stealing the current alternative minimum tax (AMT) exemption, brackets, and rates.  He is replacing them with the 2001 version of the AMT.   AMT is a tax within a tax.  It takes your regular taxable income, throws out many of your deductions, and then applies a two tiered rate structure to your AMT taxable income.  You then get to pay either your regular tax or your AMT, whichever is higher.

AMT tends to afflict taxpayers making from $200K to about $500K.  It has been a pain in the ass since the late 1970's, but it didn't affect many taxpayers until around the year 2000.  Up through 2001, the tax had never been indexed for inflation.  Finally, the math caught up to six figure earners and many of us incurred substantial AMT tax balances.  Since 2001, Congress has engaged in an annual ritual temporarily indexing the AMT brackets and rates to mitigate some of the effects of inflation on the AMT.  In 2013, the party ends.  In fact, it really ended in 2012, but most Congress watchers expect one more round of indexing before year end.

So, if you have stock options, qualified or non-qualified, exercise them in 2012.  Sell your virgin daughters to pay the additional taxes if necessary.  You have eleven shopping days left before the Grinch takes your money or your daughters.

Recently, constitutional scholars discovered some e-mail messages from the 1780's that suggest the second amendment has a typo.  Tommie Jefferson thumb typed a draft of the amendment to Jimmie Madison using his iPhone 5.  When he typed, "right to bare arms," Apple's auto correct feature turned it into "right to bear arms."  So sun dresses are constitutionally protected.  Assault rifles are not.

The next time you see a woman wearing something hideous in public, remember that thousands upon thousands of American soldiers fought and died for her right to make poor fashion choices.

As always, thanks for reading.  For real tax and accounting advice, visit our main S&K web site at www.skcpas.com.  Also, please like the "How to Screw Up Your Small Business" Facebook page.  I post a screw up of the day there.

Until next time, let's do it to them before they do it to us.

Tax Gifts from Santa (Were You Naughty or Nice)

Who will be the better quarterback long term, Andrew Luck or RGIII?  As always, I bring you the definitive answer.  I definitively have no clue.  Before the season began, I would have given you 100 to 1 odds Luck would be better.  Now after thirteen games, I'm not certain the question is even relevant.  If I'm a defensive player, I can choose death by air (Luck) or death by land and air (RGIII).  Thirty plus points is the result either way.

The funniest moment from last week's Redskins vs. Ravens game was a Raven's outside linebacker chasing and tackling Alfred Morris on the other side of the field.  There was just one problem.  RGIII had the ball, charging through the hole left by the departed linebacker.  I'll bet the linebacker felt great this week in practice watching the play on video.

This year the pedophile, who hangs out at the mall dressed in red and judges us naughty or nice, brings us gifts wrapped in dollars.  He has brought us some tax planning gifts to unwrap before the end of the year.

Th key point Santa wants us to remember for 2012 is that all of our usual year end tax planning tricks are wrong.  Usually, we accelerate expenses and deductions and defer income.  Santa knows that some of you are naughty and don't unwrap and deposit checks you receive the last week from customers.  For 2012, all of that is wrong, because if there is one tax certainty for 2013, it is higher taxes.

So bribe the mailman to bring you more customer checks to deposit before year end in 2012.  Don't mail a year of rent checks to your landlord on December 31st, unless I'm your landlord.  In 2012, we want more income and less in deductions, because our taxes will be lower in 2012 than 2013.  Here is what Santa is bringing all of you naughty high income taxpayers for 2013.

 Santa considers you a high income taxpayer if you are married with more than $250K in adjusted income.  If you are wise enough to still be single, the income amount is $200K.  For 2013, Santa wants you to remember that the true meaning of Christmas is the spirit of giving - giving to Uncle Sam.

His first red wrapped goodie is a .9% Medicare surcharge on earned income above $250K (again $200K if you're too homely to marry or are otherwise single).  If you get wage or self-employment income this applies to you.  You can, however, return at least part of this gift if you keep the receipt.  You can accelerate salary from 2013 into 2012.  That means take a couple extra paychecks, that you would have received in 2013, in 2012.

The red pedophile's next goodie is a 3.8% Medicare surcharge on investment income received by taxpayers with adjusted gross income over $250K ($200K if you divorce the wife beater by 12/31/12 or are otherwise single).  The income included in this dried out fruitcake of a present is interest, dividends, capital gains, net rental, and any other investment income.  The way to minimize this joy to the world tax is to get all the income you can in 2012.  While you cannot do much about making Apple pay an extra dividend in 2012, you can sell the stock and pay taxes on the gain in 2012 instead of 2013.  Also, this isn't the year to repair the roof on your rental property.  The deduction will be worth more in 2013.

Not only is Santa bringing us some unwanted tax goodies for 2013, the fat bastard is taking away some of the gifts he (and George Bush II) gave us in the early 2000's.  First, the 15% maximum tax rate on dividends and capital gains will be gone effective January 1st.  Dividends are slated to be taxed as ordinary income, and capital gains taxed at a maximum rate of 20%.  Happy New Year!  So if you own a C corporation that normally pays you dividends, pay yourself as much extra as you can afford in 2012 to get the 15% rate.

Earlier, I mentioned taking capital gains in 2012 when possible.  There are some other implications to this.  Don't sell real estate in 2012 using a 1031 exchange.  You will be exchanging the 15% tax rate for a higher rate in a future year.  If you sold your business in 2012 and will be receiving the payments over a number of years, elect out of the installment method of reporting the income.  Report all of the profit in 2012 and pay the taxes now.  If you are still negotiating the sale, get enough cash in 2012 to pay all of the taxes.  Your wife's fur coat purchase can wait.

The alternative minimum tax (AMT) will cost most of us making more than $200K more.  The exemption and tax rates are going back to 2001 levels.  I expect this to cost me about $12K in additional taxes, if you'd like a look at my personal pain.  I'm so happy to pay for Tiny Tim's health insurance.

Finally, for really high income taxpayers, itemized deductions and personal exemptions will phase out as they did before the Bush tax cuts.  Tax rates will also rise to pre-George W levels.  Running some rough numbers for 2013, I have seen average tax rates for people making over $400K raise by 15% or more.  That is combining all of Santa's goodies that we know he is delivering for 2013 before we even know what new tax legislation he will bring after the new year.

On Thursday night I hit a deer on the way home from work.  I didn't feel at all sad. I hope it was Rudolph.  Given the tax presents the old, fat, eggnog swilling, cookie stealing, red pedophile is bringing me for Christmas this year, I feel justified.  I'll try, and you should too, to hit some more.  If we get all twelve of his antlered buddies, maybe we can stop Christmas from coming,  Yes, I am the Grinch and I approved this message.

As always, thanks for reading.  For real tax and accounting advice, please visit our main S&K web site at www.skcpas.com.  I also publish a business screwup of the day on the "How to Screw Up Your Small Business" Facebook page.  Please like the page.  All proceeds from the page go to the Center for Orphaned Reindeer.  I believe in giving back to the community.

Until next time, let's do it to them (especially reindeer) before they do it to us.

Show the IRS Your Weenie

The mailman enters your office and delivers an ominous letter sized envelope addressed with the three most dreaded words in business English, Internal Revenue Service.  You're tempted to shred the letter, so that you can claim innocence by ignorance, but you know that won't work.

Then you get angry.  "I'm  a God-fearing, honest, taxpaying American citizen.  What in the hell do they want from me?"  Well, more taxes, dummy.

You rip open the letter.  The first page says it all, balance due $50K.  You think, "Holy hell, how can I owe that much?  I only cheated a little on my business expenses.  My girlfriend's jewelry wasn't that expensive.  It was fake."

You read further into your twelve page death notice and spot the problem.  The notice is from 2011, the year your wife learned about your girlfriend's jewelry.   You sold your marital home in the divorce receiving $500K for a house you bought for $700K.  Of course, you had to make up the $200K difference with the bank - expensive fake jewelry at that.

The good news is that you owed no taxes when you sold the house at a loss.  The bad news is that the IRS computer  doesn't know about the loss.  It only knows that you got $500K.  All you have to do is show the purchase and sale settlement statements, and the IRS will leave you alone, right?  Well maybe.  A letter of response must accompany the documentation to show that you owed no taxes on the sale.  Just sending the settlement statement will accomplish nothing.  There are three sections to an effective IRS response letter.

The first section identifies the problem.  It should look something like this.

"I am writing in response to your notice, a copy of which is attached.  The notice assesses income taxes, penalties, and interest on my 2011 individual income tax return.  The additional taxes are based on the sale of my primary residence on April 15, 2011.  I believe the notice is in error for the following reason."

There are a few things to note in this section.  First, you explain that the original IRS notice is attached to your letter.  This gives the IRS employee easy access to your case.  The notice contains internal IRS code identifying the you, the time period, and the type of issue.

Second, you very briefly identify the issue the caused the notice.  Finally, you disagree with the assessment and note that your reason for the disagreement follows.

The second section of the letter explains the issue in more detail and why you believe the notice is in error.  It should look something like this.

"On April 15, 2011, I sold my primary residence for $500,000.  Please see the attached settlement statement.  The house was purchased on June 17, 2006 for $700,000.  Please see the attached settlement statement.  I incurred a loss on the sale of $200,000, which is a nondeductible loss and nontaxable sale of a primary residence."

This second section includes the detail necessary for the IRS employee, with the misfortune of handling your case, to determine that you owe no taxes and resume surfing the internet for porn.  It also references all of the supporting documentation supporting your conclusion.

In the third and final section, you show your weenie.  Put your cell phone down.  I'm not talking about enclosing a picture of your junk.  That has never worked for me.  Paul and I coined the term, weenie, to describe the section of the letter where you tell the IRS what action you want them to take.  When one of our staff prepares an IRS letter without asking for specific IRS action, we ask, "Where's the weenie?"

A couple years ago, I met with a new client, who was having trouble getting the IRS to resolve a payroll tax problem.  She didn't owe any money, but still the IRS was hassling her.  She gave me a four page letter her previous CPA had written.

The letter had an enthralling plot, memorable characters, and the prose was riveting.  There was just one problem with the letter.  It never asked the IRS to do anything.  So they didn't.  The tax balance just continued to accrue interest and penalties, and the IRS continued trying to collect them.  I wrote a three paragraph letter, and the tax balance went away.  My weenie was the key.  In our example, the weenie section should look similar to this.

"Therefore, I ask that you remove the assessed taxes, interest, and penalties from my 2011 individual income tax return.  If you have any questions, please contact me at the address listed in your records.  Thank you in advance for your assistance."

As you can see a weenie doesn't have to be long to be effective.  Keep it short, but penetrate to the core of what you want done.

Keep the length of the letter to one page, two pages at a maximum.  The IRS employee must be able to grasp your situation and why you are correct in a minute or two.  Also, nowhere in my example do you see the terms, douche bag, asshole, moron, skank monster, or subhuman vermin.  Experience has shown these terms to be ineffective even if accurate.  You are also well advised to avoid references to assumed ancestry, suspected inbreeding, or sexual acts preferred by someone's mother.  All of these references are superfluous and need not be expressed.

Receiving an IRS letter isn't one of life's little joys, but you shouldn't lose sleep over one.  Most IRS letters result from mismatches between your tax return and information the IRS received from someone electronically.  According to taxworks.com, IRS notices increased from 30 million in 2001 to 201 million in 2009.  Those numbers will only increase in the coming years with the federal budget crisis pushing the IRS to recover more uncollected taxes.

Finally, if you don't understand an IRS notice, most are written in an indecipherable dialect of bureaucrat-ese, seek professional help.  Yes, we charge for this, but we can often save months of frustration and continued nasty notices.  I have seen most notices before, and I have prepared responses that worked for someone else.

My Thanksgiving prayer for the Redskins worked.  We were treated to a fabulous Skins flick titled, "RGIII does Dallas."  Truth, justice, and the American way prevailed.  God bless America - and the Redskins.

As always, thanks for reading.  For real tax and accounting advice, please visit our main S&K web site at www.skcpas.com.  Let's do it to them before they do it to us. HTTR.

Cry Over the Election

Yesterday I had six panicked e-mail and telephone messages from business owners despondent over the results of the presidential election.  Some of these people won't even be impacted by increasing taxes.  They don't make nearly enough money.  In fact Mitt Romney would probably consider them part of the 47%.  All they know is that they have been told to panic over the President's reelection.

Here's some free advice.  The election's over.  It's time to put on your big boy panties and move on.  Shortly, I'll have some advice for continuing to prosper in a increasing tax rate environment.  But first, I have a few more paragraphs of ranting to put you through.

Here's a message to my fellow Republicans.  There will NEVER be another Republican president until we realize that the country is fifty percent female.  The vast majority of women are pro choice or anti anti abortion.  Use whatever dumb ass label you like.  Women will not even seriously consider voting for a pro-life or anti abortion candidate - more dumb shit labels.  Abortion was a wonderful political topic for the twentieth century.  But now we are in the twenty-first century.  The party needs to move to this century as well.  This topic is settled, because more than half of the country favors abortion.  That is how a democracy works.  You don't always get your way.

Here's another hint for my fellow Republicans.  We have to have a reasonable position on immigration.  We have no problem paying illegal aliens to mow our lawns.  We just don't want them voting.  Not surprisingly, a lot of people, apparently a majority, don't find this reasonable.  We need to stop deciding who we want to exclude and start considering whom we should be recruiting for citizenship.  Again, a little living in this century would help.  My wife read this and pointed accusingly at me.

While our beloved Republican Party drones on debating topics from the last century, we miss opportunities to improve business conditions.  Let's discuss the FCC for a moment.  FCC stands for Freaking Censorship Commission.  No I cannot bring myself to use the real "F" word, but feel free to insert it.  They are far more concerned about whether a Howard Stern clone shouts "penis" on the radio than they are about the quality and price of our cell phone service. 

We should be pressuring them to separate selling cell phone service from selling cell phones.  The service would improve and the price of both would go down.  We also need to pressure them to make wi-fi and broad band ubiquitous across the country.  These are issues that truly affect business growth in THIS century.

 

Enough ranting.  We have the government we deserve.  I would like to blame the Democrats for that, but we are more to blame.  We let the religious whack job wing of the Republican Party choose our candidates.  And they lose - deservedly.

 

Here are some thoughts on continuing to prosper in a higher tax environment.  First, quit obsessing over taxes.  The most important part of running a small business will still be earning a profit.  Yes, you will keep less for your efforts, but the effort you spend worrying about taxes is effort better spent growing your revenue.

Second, do everything you can to defer income until we get a new tax regime.  For the past few years, I have been advising against section 1031 exchanges.  A 1031 exchange is the exchange of one asset, where you have a gain, for another asset.  When you do that, you get to defer the taxes on the disposition of the first asset until you sell the second one.  This used to be a popular real estate strategy to defer taxes.

For the past few years, I have recommended against this strategy, because the long term capital gains tax rate was only 15%.  We are now almost certain the capital gains tax rate will increase in 2013.  If you did an exchange in 2012, you gave up the 15% tax rate in favor of a higher tax rate later.  That wasn't a particularly bright strategy.  Undoubtedly the clients, who didn't take my advice, will call to bitch at me soon.

Starting in 2013, section 1031 exchanges now make a lot of sense.  If the capital gains tax rate goes to 28% or more, why not gamble that rates may be lower in four years.  If nothing else, the time value of money will make the taxes hurt a little less in the future even if the tax rate doesn't go down again.

Third, C corporations may come back into favor for small businesses. I'm not certain about this.  So stay tuned for more on this as we know more about what will happen to corporate tax rates.  There has been a of of talk about decreasing corporate tax rates and removing the incredible array of special interest deductions and credits that large corporations use to basically pay no taxes.

I have recommended against C corporations since before dinosaurs roamed the earth, which was only 5,000 years ago if you believe Sarah Palin.  The double taxation on profits, even with a 15% tax on dividends, made S corporations a better tax choice.  With lower corporate tax rates, the math may change my recommendation.  As you know, I'm all about the math.  There may also be some special provisions to lower the taxes on the sales of small C corporations.  I'll be certain to let you know as this develops.  It's the least I can do since you are kind enough to put up with my rants.  I will have more suggestions as we know more about tax law in 2013 and beyond.

On Election Day, I tried to impose my solution to the immigration problem.  I stood in front of my polling place and passed out algebra tests.  That didn't make me popular.  Of course, all of the great social leaders in history, like Gandhi and Reagan, weren't successful at first.  Fortunately the Loudoun County jail has good internet access.  Otherwise, this never would have been written.  They have a great breakfast here, better than most of the breakfast places in California.  All of the breakfast places in California have "Pain" in the name.  "Pain" is French for "Let's rip off the stupid Americans."

 As always, thank for reading.  For real tax and accounting advice, please visit our main S&K web site at www.skcpas.com.  Until next time, let's do it to them, before they do it to us.