Category Archives: Taxes

Ways in Which the IRS Examines the Differences Between a Hobby and a Business for Income Tax

A popular cliche states that a small business is “only a hobby before it is making real money”. Or, at least until it breaks even. For income tax purposes, the IRS is very concerned with whether your enterprise is a spare time activity. The reason for this is basic. The IRS doesn’t want to discover individuals taking tax deductible losses each year regarding an operation that resembles a tax shelter. If you have a business which continually has a loss of profits plus it falls into a niche in which the IRS has considered to be a traditional hobby, you should be very cautious.

To begin with, the business should be opened with your intent of generating positive income. Furthermore, it’s essential to be able to show that you have managed this opportunity like a business venture. This requires being organized by preserving records data, separating bank accounts from personal use, and creating a valid plan to make a profit. The Internal Revenue Service will be looking at other things including additional types of earnings and whether or not you handled your business as if it were a regular, full-time profession. Should you have a deductible loss, you’ll need to be able to demonstrate that you put in the actual time and effort to do everything possible to make a profit.

In addition, if you can show that your company has been profitable in past years, the IRS will likely be less strict with you. Historic profits are valid evidence that the venture idea was logical and that your net losses are reasonable for tax reasons.

Another thing that the Internal Revenue Service will likely ask about is which areas have you engaged in business prior to this venture. For example, let’s pretend you began an internet business in Silicon Valley and made $50 million when you sold this company. Then you make a decision to go into semi-retirement mode and buy a big vineyard in the same region. Realizing that it’s difficult to generate income from the wine business, you incur negative earnings for 3 years in a row. In such cases, the IRS may identify that you previously enjoyed some other source where you received your money. Furthermore, you had no previous experience in the wine sector. Since you are semi-retired, you are not actively employed in the vineyard. On top of that, you’ve got another individual managing the vineyard.

Buying a vineyard could have been a lifelong dream you had. This is also a business whereby other people in equivalent cases have gotten into. The IRS can take this into consideration. This market consists of a large amount of vineyard owners which have not been reliant on the cash flow with this business. Hence, the IRS will identify that your particular vineyard is a hobby.

Using this example, the IRS will likely evaluate the economic track record of the business. If a 5-year duration passes by and you make a profit in 3 of those years, the IRS will likely approve a business loss. The reason is that the winery was profitable most of the time within the past five years. Many times, there is a thin line between hobby and business losses. Whenever you realize you are in a predicament that is questionable, talk to a tax expert.

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How to Take a Vacation and Write it Off Your Income Taxes

How could you take a trip and also make it tax deductible? There are a couple of possibilities. First, you can do volunteer work. Second, when you have your own company, there is a lot of options. These can include training seminars that are ideally located in top notch vacation zones. However, you should be cautious whenever taking vacation write-offs due to the fact that not all expenditures will be allowable. For example, should you stay in that location several additional days to go sightseeing, then your costs regarding the additional stay are, in general, not deductible.

There are many non-profit organizations that give the opportunity to do volunteer work relating to a charitable purpose. Most of these opportunities commonly require a number of costs in which you could possibly get a tax deduction. In these circumstances, you may have out-of-pocket costs including airline tickets, rental accommodations, plus food. A few of these establishments include Habitat for Humanity, Cross-cultural Solutions, and United Planet. As a standard guideline, your charitable endeavours should be equivalent to working a full-time job throughout the duration of the trip. If you stay at the location that you performed your charitable labor after the job was finished, that part of the trip isn’t going to be deductible.

Many professions require continuing education. Because of this, there are various courses and workshops being offered in many nice vacation zones. Through some meticulous planning, you’ll save on income tax while satisfying your needs to stay certified.

The Internal Revenue Service might audit these write-offs so be sure that they are reasonable. For example, traveling to a seminar located in Hawaii won’t be sufficient to deducting tickets to a theme park. Furthermore, you could deduct your air travel but you should never write off the travel expenses for your children or your significant other unless they’re important employees of your business. If you’re feeling that something you’re considering to deduct is questionable, then you should either pass on it or consult a reliable income tax advisor. You should not be discouraged by this. If your trip is organized appropriately, you will still be able to write off a considerable portion of the costs.

Be mindful if your vacation involves something like a 2-day seminar and a couple days of sightseeing. In this situation, you are unable to write off the entire excursion. The primary reason for the excursion must be the seminar and you may only write off your flight costs (not the rest of the family’s) and hotels for the time period when the seminar was held. In cases where you write off all the expenses, the IRS will likely disallow the items not directly related to business. You should also document precisely why the vacation was taken. An additional basic guideline regarding business trips is to make sure that the costs of your getaway are normal in your industry.

Remember, you should get expert advice during the planning phase of your trip.

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Corporation vs. LLC – Tax Benefits of Each

Determining the best entity for your business is a complex but important decision that you will make.

[youtube http://www.youtube.com/watch?v=bLQmsJP35rc]

Corporations and LLC’s offer liability protection. Without Liability Protection, anytime you interact with another person, there is a risk. From a liability standpoint, think of an LLC or Corporation as insurance for your personal assets. By operating as a Sole Proprietor or Partnership, you are personally liable for all business debts. You are also potentially liable for any lawsuits that may arise. Sole Proprietors and Partnerships also must pay self-employment tax on the net income of the business.

LLC’s are the simplest to form.  They do not have formalities and record keeping requirements that Corporations have.  For tax purposes, the financial data passes through to your personal return.  You generally owe self-employment on your net income up to $106,800 for 2010.  However, you can elect to be taxed as an S-Corporation.

S-Corporations offer the opportunity to save on self-employment taxes after paying a reasonable salary.  Like a C Corp, Payroll taxes must be paid for salaries and wages.  However, there is no payroll tax on the extra income your company makes. 

As a business owner, you cannot abuse this benefit.  You cannot take an artificially low salary with the sole intent of avoiding payroll taxes – hence the term reasonable salary. 

The main drawback for an S Corporation is the lack of easy operation. There are differences in formalities and record keeping requirements.  For example, you must have shareholders and stock  – as well as a board of directors and officers.

C-Corporations are similar in structure to an S-Corporation.  The tax on salaries and wages is essentially the same.  This entity type can save money for high income earners.  For example, if you (personally) are in the highest income tax bracket, you can leave a portion of your profit inside the C-Corporation.  This saves tax dollars because the first $50,000 in corporate profits is taxed at the 15% rate.  By splitting the income, you may be able to stay out of the top tax brackets.

The main drawbacks with a C-Corporation are the same as those of an S-Corporation.  They lack ease of use, they have a more complex structure and are more formal, they require more maintenance, and they both require having to file another tax return.

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The Complete Tax Code is Over 60,000 Pages!

Since it’s time to celebrate the last day of tax season, here is a video and some facts regarding income taxes:

Facts for 2010:

  • Tax code is over 60,000 pages
  • About 45% of households will not pay federal taxes this year
  • $431 billion is spent annually complying with the tax code
  • Top 400 earners will pay an average of 17%
  • More people work in the tax industry than Wal-Mart, UPS, McDonalds, IBM & Citigroup combined

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Why You Should Never Buy a Home for Tax Reasons

Most people generally overweight the value of income tax savings form buying a home.  The amount of savings depends on two factors: the amount of money you borrow and the tax bracket in which you are in.  It is also important to note that only the amount that exceeds your standard deduction ($5,800 if single or $11,600 if married filing joint) will reduce your taxes.  This is why this deduction is more favorable to high income earners if they finance an expensive property.  Beware of tax accountants, real estate agents, and mortgage brokers who advise you to buy a bigger house.  If you decide to purchase a larger home, you should have reasons that are far more important than taxes. 

The Tax Policy Center blog writes, “A new analysis by my Tax Policy Center colleagues Ridathi Chakravarti and Dan Baneman finds that most taxpayers would barely notice the change in their tax bill even if Congress dramatically restructured the subsidy. And with some changes, many of us would end up paying lower taxes than we do today.

In the unlikely event Congress simply repeals the mortgage deduction, the average tax bill would increase by $710. But those who earn between $30,000 and $40,000 would pay an average of about $70 more while those making more than $1 million would pay an additional $4,000.

It is certainly possible that policies regarding real estate related deductions will change in the next few years.  With large budget deficits mounting, mortgage interest deductions could be targeted by Congress to make up for the shortfalls.  If things do not change, definitely take advantage of it.  But, never put yourself in a situation in which you are banking on a tax policy.

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Bill Gross Thinks Taxes Should be Much Higher

Warren Buffet isn’t the only member of the ultra-wealthy that openly says that income taxes for high income earners should be much higher.  Bill Gross, a bond investor for PIMCO, also believes the rich should be taxed more.  He stated that high income earners have enjoyed an enourmous privilege since the Regan administration and that high income earners should be taxes at over 50%.  Ouch!!

Corporate tax rates, as a percentage of GDP, are at a historically low rate of 1% according to Gross. Another emerging problem among state and local governments is that businesses theaten to leave the state/region if taxes increase as a deterrent.

An increase of this magnitude seems a bit extreme.  The biggest problem with this, especially with corporations, is that it would put international businesses at an even bigger advantage.  Businesses would consider relocationg to a country in which taxes are low.  US companies would struggle to compete with them.

Video Link:

http://cosmos.bcst.yahoo.com/up/fop/embedflv/swf/fop_wrapper.swf?id=24440532&autoStart=0&prepanelEnable=1&infopanelEnable=1&carouselEnable=0

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This Year’s Tax Changes (for the 2010 Filing Year)

[youtube http://www.youtube.com/watch?v=wswSIUmgf54&w=480&h=390]

Income Tax Changes for 2010:

Standard Deduction Increased

The standard deduction for those not filing Schedule A has increased. The new standard deduction amount depends on your filing status.

First Time Homebuyer Credit

You may be able to claim this credit if you entered a written binding contract before May 1st, 2010 to buy the home before July 1, 2010 and completed the purchase before October 1, 2010. Certain members of the armed forces and other taxpayers have additional time to buy a home and take the credit.

Repayment on First Time Homebuyer Credit

If you claimed the First Time Homebuyer Credit for a home you bought in 2008, you generally must begin repaying it on your 2010 Tax Return. In addition, you generally must repay any credit you claimed for 2008 or 2009 if you sold your home in 2010 or the home stopped being you main home in 2010. If you claimed the First Time Homebuyer Credit after January 1, 2009, you are not required to pay it back.

Roth IRA’s

Beginning in 2010, you can make a qualified rollover contribution to a Roth IRA regardless of the amount of your Modified Adjusted Gross Income. Also, half of any income that results from a rollover or conversion to a Roth IRA from another retirement plan in 2010 is included in income in 2011, and the other half in 2012 unless you elect to include all of it in 2010.

Self-Employed Health Insurance Deduction

If you were self-employed and paid health insurance premiums, you may be able to include with your self-employed health insurance deduction any premiums you paid to cover your child who was under age 27 at the end of 2010, even if the child was not your dependent.

Standard Mileage Rate for Deductible Mileage

For 2010, the standard mileage rates are:
• 50 cents a mile for business use
• 16.5 cents per mile for medical use
• 16.5 cents per mile for moving expenses
• And 14 cents a mile for charitable use

Personal Casualty and Theft Loss Limit

Each personal casualty or theft loss is limited to the excess of the loss over $100. This amount is different from the $500 limit for 2009. In addition, the 10% of adjusted gross income limit rule generally applies for the net loss. Congress is considering changing this regulation so check our website for the most current information.

These are the most important changes for 2010. Visit www.Taxes-PhD.com for more.

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Tax Relief Act of 2010

Below is a video on the Tax Relief Act of 2010 and what it means for your business.

[youtube http://www.youtube.com/watch?v=LDOBr3CaNT0&w=480&h=390]

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