Question:

I understand where retained earnings come from(accumulated earnings over years). But when it climbs significantly higher in one year, and I have all “said” info entered, (owner takes no draws or cash out for anything, he gets healthy W2 wages all year) then it seems like there’s something missing-possibly money spent toward assets?

Like, on the Sch M1 & M2:

Is there ways to reduce Ret. Earnings? What about the payments he makes toward big assets during the year? Can they be used anywhere? I have used the interest on these loans as a deduction and they are set up on depreciation.

I know Sch. L has to balance. I’ve been told to adjust either A/R or loans from shareholders to make this happen. What do you suggest?

Answer:

Any retained earnings would normally be added to investor equity. Since they already paid the taxes on it (and BIG personal taxes they did pay as a sub-s). Investor equity is the buffer, as the business becomes more profitable and retains profit the value for each unit of investment goes up, if the business is strapped and is operating out of the money originally invested then the investors value drops.

As far as reducing retained earnings; spend the money is one way, that would allow for purchases of big assets. This is where the 179 deductions plays in. For 2008 the 179 deduction is $250,000 for anything that depreciates in less than 20 years.

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 Question:

What are the options in the following situation:

Dad dies and the estate is left with an outstanding mortgage on a building that has 2 children living in 2 of the 3 apartments. They both want to stay, what happens with the mortgage? Only one child might be interested in continuing to pay the mortgage. Is that even possible? Can the mortgage be transferred to the interested child or does the dwelling need to be formally sold publicly first? Who decides the sale price?

Answer:

The lender would probably not allow for a straight assumption, the buyer would have to qualify for a new loan.

The sale price would be determined by the buyer and seller. If you can’t agree there is no sale.

Everyone needs to decide what they would be willing to buy it for and what each of them would be willing to sell it for. If you are not sure what you would sell it for, you could get an appraisal, realize that it is not going to sell at appraised value, especially not in this market. You could put it on the market and see what offers you get, and then if anyone wants to buy at that price they can.

  The one that does not want to buy should get ready to move or negotiate a fair rent to stay in it.

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 Question:

 I am a working artist who, like most creative folks, has a full time day job as well to make ends meet.

 I have a Live / Work Studio that I declare the work portion of each year, I have material costs throughout the year, and I also have promotional expense to promote my work in the world, of which I also declare.

As for art related income, some years I have sales, some years I do not.

I keep track of all my art related expenses and income.

What are my risks for an audit, and how can I reduce them?

Answer:

The potential for audit and the potential to lose in an audit are two separate concerns. Obviously we want to avoid both. And the third part of this is the “1 in 3, 2 in 5 rule”

 Having good records will give you argument points if you are audited. When individuals are audited, there are some very common areas where they cheat: understating income and overstating deductions are quite common. As long as you can justify the expenses (according to IRS rules, not just your perception of the rules) and you track all the income, then if you are audited, you’d probably win.

Avoiding the audit in the first place however is a worthy goal.

As an individual in business, You have a high likelihood of audit. Check the numbers: www.irs.gov/pub/irs-soi/07databk.pdf look at page 23 and 24. You’ll see that as an individual tax return that does not have a schedule C attached has about a 0.4% chance of audit, attaching a schedule C can raise your audit risk to 9.7% (a little over 25x more likely)

While doing your business as a Real corporation would reduce your risk, just by the numbers, assuming you are not carrying a balance sheet, would be 0.5% audit risk as a real corporation.

 Not only would your risk of audit be far less, you’d enjoy lower taxes as a real corporation.

 The 3rd item above was the “1 in 3 and 2 in 5 rule”: The IRS can re-categorize any business that fails to make a profit, one out of three and 2 out of 5 years. This would result in disallowing all deductions and attributing that is income to you which you would have failed to pay taxes for and now would be subject to penalties and interest.

SOooo, let’s make “profit” a priority. If you have not made profits in enough years to fit within that rule, then close the doors of the business, hunker down and wait 3 years. Once you get past that, you are safe. In the mean time you could open a corporation to do business; THAT CORPORATION has a new 1 in 3 and 2 in 5 clock that starts.

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 Question:

I am a contract employee. The company I work for is located in Boston, Ma. The company I am assigned to work at is in Phoenix, AZ. My home is in New Mexico. The GSA per diem rate is about $80.00 more per day than what the companies are paying me. Are they required to pay me the GSA rates?

Answer:

No. They can pay as much or as little as they can negotiate. The GSA per diem is really a Maximum number; they are limited to not being able to deduct more than the GSA per diem rate. So if the negotiation was for $275 a day, they would only be able to deduct part of the $275 (within the rates in IRS pub 1542).

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 Question:

I have been a consultant and am now an account exec with a staffing and recruiting company. My particular practice sells consulting services more than we do staffing and it seems that the taxes for our jobs are complicated and I wondered if it was just a lack of knowledge from our tax department.

Here is an example:

A consultant is assigned to a company that is based out of Tampa, FL. The consultant lives in Pittsburgh, PA and does some of their work from home. At other times they are working at customer sites in Ohio, or Illinois, or elsewhere in the country.

What taxes (for which states) should be taken from the consultant?

And which taxes should be billed to the customer?

Answer:

As to what to bill the customer? That should be decided and stipulated in the contract, whether the customer is paying “cost-plus” or simply a gross amount.

For taxes, the Federal taxes are consistent from state to state, so All the Social Security, All the Medicare, All the workers comp will be the same for each dollar earned, regardless where it was earned.

The “income tax” will need to be paid to each state based upon the state rules. If the person resides in PA then all of their income is subject to the PA income tax of 3.07%. They can deduct taxes paid in other states, so if they work for a company in Illinois they’d owe Illinois 3% of the income derived in Illinois.

Ohio has a tax rate that starts at 0.618% and slides up to 6.24% so it can be very confusing.

The fact that the company is in Florida (a no-state tax state) has no benefit for the PA residing employee.

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 Question:

We’ve been incorporated since May 1, 2007 and started renovation & improvement of leasehold property in August 2007. It took more then a year and we are still not open for business. We signed shareholders agreement, minutes and bylaws only in August 2008, 15 months after incorporation. Our fiscal year ends on December 31. Should we file initial report for 2007 ending 12/31/2007 if it has only assets & liabilities and other lines are zero? The second question is some of the fixed assets and leasehold improvements accrued in 2007 when the corporation was not operating . 2008 will be the year when we start operating business and in the 2008 report we will claim to expense fixed assets and leasehold improvement accrued in 2008, and what about 2007s purchases and improvements ?

Answer:

The corporation is required to file a tax return every year.

Filing for 2007, will allow you to memorialize expenses that did occur and can be carried forward into 2008 and beyond.

Follow-up Question:

I’m very satisfied with your answer and I dare to ask you one more time. I’m so called treasure of the company but people don’t obey my requests and that’s what happens sometimes. We have construction going on and have employed incorporated small business companies that have EIN, that they provided. When they bill us for performed work, it has happened to be not me who signs the checks, for example president of the corporation, and he signs checks not to the company name but to John Smith, because that’s how he knows him. So we have bills from the corporations and payments issued for the company owner . And that’s what was going on for a long time. Should I consider that payments were made for corporate business or it was made for persons, request their ss and and file 1099 ?

Follow-up Answer:

The IRS will not allow the business to deduct payments to individuals without a completed 1099.

The IRS will require that you (your business, each individual that has signing authority on a bank account, etc) pay unpaid payroll and income taxes on payments to individuals, if that individual is considered a common-law employee and fails to pay their own taxes.

If the payment was to the individual then it is incumbent upon you to file accordingly.

Penalties are bad.

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 Question:

I’m a self-employed website designer. Can I deduct the following as business expenses?

Answer:

First: are you profitable?

If you are not, then the deduction does not do any good for the business. If you are not profitable, you are paying no taxes. It doesn’t go lower than that.

If you are not profitable, and you try to pass the deduction to you so you can take it personally, you are going down a slippery slope. If you will not be profitable, the IRS has policies in place to disallow your deduction later and have you pay all the back taxes and penalties and interest. Not good.

If you are not profitable, change that. That should be your only focus.

If you are profitable, then the laptop is expensable under section 179.

The travel, including the airfare can be deductible as long as you are confident that you can convince an IRS auditor that it was a necessary and reasonable business trip.

The apartment could be partially deductible, as long as fit within the rules.

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 Question:

I want to know when you start a sole proprietorship. I will be doing business in Little Rock, Arkansas. What taxes are you responsible for collecting and who are you responsible for submitting taxes to? I understand that you must collect sales tax on merchandise that is sold. Also, I understand that you must file a tax return at the end of the year with your regular tax return. Also you must pay state ad local taxes. Is there any stone I’m leaving unturned?

What are the advantages & disadvantage of starting a sole proprietorship?

Answer:

A sole proprietorship is the default business structure if you do no planning. The first time you sold a glass of lemonade, or a baseball card to a classmate, you were a sole prop. That means you were the business solely.

Sole Prop is not a good business structure, it is the business structure you end up in if you have no structure.

You will pay the highest possible tax, you will have the fewest deductions, you will have no protection from lawsuits and everything you own can be lost by the business.

If “I WILL BE doing business” turns in to “I AM doing business” and you didn’t formalize your structure, you will automatically be a sole prop. Call me and we’ll talk about other options that are far better.

As for taxes, all businesses must file tax returns annually, as a sole prop you attach “Schedule C” to your personal 1040 tax return For federal income tax purposes. You must also pay quarterly payroll taxes and any withholdings.

State taxes must also be paid.

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 Question:

I’m thinking about starting an e-commerce business. I have read some of your previous answers and you have convinced me that a C corp is the way to go. My question is what state should I incorporate in? I live in NYC, which as you know is not the best place to incorporate. Should I incorporate in Nevada and file as a foreign corporation in NY? If I automate and outsource all business functions out of NY, do I have to be registered as a foreign corporation?

Answer:

The responding question is “What state will you be operating in?”.

You are right, that NYC is tax heavy, but if you operate there you’ll be required to pay taxes there. Where you file has no tax benefit. Where you file could have liability and privacy benefits, but let’s not confuse things right now.

So, were talking about taxes. And NY state has a pretty high 7.5% (not as high as Minnesota, California, Delaware, Indiana, Alaska, Washington DC, Maryland, West Virginia, Pennsylvania, Massachusetts, and Rhode Island) but with the New York City tax, I think you could be close.

AS a REAL Corporation, you’d pay tax on net profit, so the way to lower your taxes in NYC is reduce your profit in NYC.

Now if some of that NYC business income were paid as an expense to a . . . (oh, I don’t know) . . . Nevada Corporation where the state tax was zero. As long as the Nevada Corporation was really in business and operated in Nevada, then I guess we just cut a huge amount of tax.

Please don’t take the above as a complete instruction manual to solve the problem. It is far too brief and does not address many critical issues, but I hope it is a quick view at a possible way for you to be more successful in your business.

If you understand what I just explained, please call me.

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 Question:

We are cash basis. We loaned a company $90,000 on a secured interest bearing note. They quit paying interest last year. We have found another company to purchase the security for $90,000 which we will lend them. However, the accrued unpaid interest will never be collected. Should we send the old debtor a Form 1099 for the accrued but unpaid interest that they will never pay? Since we never received the interest, do we have to report and then take as a bad debt?

Answer:

What was the collateral for the “secured” note?

The unpaid interest would be transferable to the new note holder. You would be selling them the right to recourse which means they can attempt to collect it all.

Unpaid interest is not a forgiveness of debt. Unpaid principal is a forgiveness of debt, but you wanted to transfer the principal, not forgive it.

For tax purposes, since you did not receive the interest you owe no tax on it, and therefore would provide you no reduction on taxes for not receiving. If that were not so, I’d have a few million dollars of tax deductions from all the interest I never received.

Your financing the purchase of the note provides no benefit. If you simply wanted to transfer the right to collect, there are simpler ways.

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