Category Archives for "Taxes"

Tax Cuts and Jobs Act – See How It Would Affect You (Business Version)

By Mike Jesowshek, CPA | Taxes

If you have been reading social media the past couple weeks you will notice that there is suddenly thousands of tax professionals sharing their opinions and “knowledge” of the tax reform bill. Unfortunately with all this knowledge there are many rumors and mixed information being spread around. This is why we have provided a complete breakdown of all the changes and how they MAY affect you.

The House Ways and Means Committee included a substantial number of proposed tax changes affecting businesses in the Tax Cuts and Jobs Act. This article covers those proposals generally affecting self-employed taxpayers and small businesses. When reading the information included in this article, please keep in mind that it is PROPOSED legislation and is not law yet. However, it does give you an insight to what may be coming. These provisions would be effective in 2018 unless otherwise noted.

Maximum Tax Rate on Business Income of Individuals – Among the goals that the Republicans want to accomplish with tax reform are simplification of the tax code and making it fairer. However, those two aims seem to collide when it comes to how they propose to tax higher-income individuals on their pass-through income. The proposed approach will complicate tax returns for many of these individuals.

Currently, income from a self-employed business, partnership and S-Corporation is passed through to the business owner, or the stockholder in the case of an S-Corporation, and is subject to the taxpayer’s personal income tax rates.

Under the proposed act, a portion of net income distributed by a pass-through entity to an owner or shareholder would be treated as “business income” subject to a maximum rate of 25%, instead of ordinary individual income tax rates. The remaining portion of net business income would be treated as compensation and continue to be subject to ordinary individual income tax rates.

Owners or shareholders receiving net income derived from an active business activity (including any wages received) would determine their business income by reference to their “capital percentage” of the net income from such activities.

• Owners or shareholders generally would be able to elect to apply a capital percentage of 30% to the net business income derived from active business activities to determine their business income that would be eligible for the 25% tax rate. That determination would leave the remaining 70% of net business income subject to ordinary individual income tax rates.
• Alternatively, owners or shareholders would be allowed to elect to apply a formula based on the facts and circumstances of their business to determine a capital percentage of greater than 30%. That formula would measure the capital percentage based on a rate of return (the federal short-term rate plus 7%) multiplied by the capital investments of the business. Once made, the election of the alternative formula would be binding for a five-year period.

In most cases, taxpayers actively participating in businesses involving the performance of services in the fields of law, accounting, consulting, engineering, financial services, or performing arts (i.e., personal service businesses) would not be eligible for the 30% capital percentage but would be allowed to use the facts and circumstances formula.

Business Expensing – Under current law, when a taxpayer acquires a business asset, a taxpayer must depreciate the cost over the asset’s useful life. However, a taxpayer can utilize the bonus depreciation allowance or Sec 179 expensing rules to increase the write-off in the first year. The act would permit 100% unlimited expensing of tangible business assets (except structures) acquired after September 27, 2017, and through 2022. This provision would apply for the tax year when a taxpayer first uses the asset. The asset would not need to be new to qualify for the unlimited expensing.

Sec 179 – Currently a taxpayer may immediately expense up to $500,000 of the cost of Section 179 property, with the deduction phasing out when the costs of eligible property exceed $2 million. These amounts are inflation-adjusted and for 2017 are $510,000 and $2,030,000, respectively. The act would increase the annual expensing limit to $2 million, and the phaseout would begin at $20 million. If enacted, this provision would be effective for assets purchased and placed in service after 11/2/17.

Business Interest Expense Limitation – Under the act, the interest deduction for businesses would be limited. However, the act carves out an exception for small businesses with gross receipts of $25 million or less.

Business Entertainment – Under current law, when a taxpayer establishes that an item was directly related to the active conduct of the taxpayer’s trade or business, a taxpayer can deduct 50% of the cost of business entertainment. Under the act, no deduction would be allowed for entertainment, amusement or recreation activities, facilities, or membership dues relating to such activities or other social purposes. However, the 50% limitation would continue to apply to expenses for food or beverages and to qualifying business meals.

Sec 1031 Exchanges – Under current law, gain from the exchange of most business or investment property can be tax-deferred when the property is exchanged for like-kind property. Under the act, tax-deferred exchanges would only be allowed for real property after 2017.

Self-Created Property – Under current law, a self-created patent, invention, model or design (whether patented or not), or secret formula or process is treated as a capital asset and subject to capital gain rates when sold. Under the act, these items would be subject to ordinary tax rates upon sale. In addition, the election to treat musical compositions and copyrights in musical works as a capital asset would be repealed.

Domestic Production Deduction (DPD) – Under current law, taxpayers are able to claim a deduction equal to 9 percent (6 percent for certain oil and gas activities) of the lesser of the taxpayer’s qualified U.S. production activities income or the taxpayer’s taxable income for the tax year. The deduction is limited to 50 percent of the W-2 wages paid by the taxpayer during the calendar year. Under the act, the DPD would be repealed after 2017.

Business Credits – The act would make the following changes to business tax credits:

• Employer-provided Child Care Credit – Repealed
• Rehabilitation Credit – Repealed
• Work Opportunity Credit – Repealed
• Deduction for unused business credits – Repealed

Corporate Tax Rate – Currently the corporate tax rate is made up of four graduated tax brackets: 15%, 25%, 34%, and 35%. The act would make the corporate tax rate a flat 20%.

Personal Service Corporation Tax Rate – Corporations whose principal activity is the performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting and where such services are substantially performed by the employee-owners, would no longer be able to use the graduated tax brackets and would be taxed at a flat rate of 25%.

Net Operating Loss (NOL) – Carryback of NOLs arising after 2017 would be repealed, except for a one-year carryback allowed for a loss in a federally declared disaster area incurred by a small business (gross receipts under $25 million) or farming trade or business. The carryforward period, which is currently limited to 20 years, would become indefinite, and the loss deductible in any carryforward or carryback year would be limited to 90% of that year’s taxable income (figured without the NOL deduction). Additionally, for NOLs incurred after 2017 and carried forward, an interest factor would be applied each year that would increase the amount of the NOL to preserve its value.

The foregoing only includes the major changes, and there are other details not covered. Of course these are proposed law changes, and there is no assurance these changes will pass into law. Even if the provisions are enacted, there is no guarantee they will not have been altered from the form described above. If you have questions or concerns about these proposals, please give this office a call.

Following Congress on its Path to Tax Reform

By Mike Jesowshek, CPA | Taxes

As Congress begins debating tax reform, you might be interested in an overview of the GOP’s proposed changes so you’ll have an understanding of what the proposals actually entail as you follow the debate and won’t have to rely on politically motivated analysis by the various media sources. It is important to understand that the GOP’s tax reform proposal is actually only an overall framework of the tax legislation that will be formulated later by congressional committees. So it only provides the “big picture,” with details to be added later. However, the devil is always in the details, and you frequently have to read between the lines and listen to and read comments by Washington insiders to glean additional detail. Based upon that, the following are the provisions of the proposed tax reform that will apply to individual taxpayers and small businesses.

Filing Status

Current Law: The current law includes five filing statuses: single (unmarried), married taxpayers filing jointly (MFJ), head of household, married filing separately (MFS) and surviving spouse. The head of household (HH) status is for single individuals and some married but separated individuals who are maintaining a home for a dependent. MFS is a filing status that applies to a married individual who is not filing a joint return with their spouse (it keeps married individuals from filing as single and abusing the intent of the tax laws). Surviving spouse is a status that allows a widow or widower with a dependent child to continue to use the joint tax rates for 2 years after the year of death of their spouse.

Proposed Law: It appears that the proposal would retain only the single and married taxpayers filing jointly statuses in an effort to simplify the tax law. If this is the actual intent, it would greatly streamline the tax code, which is littered with special treatment for HH and MFS taxpayers. Potential losers under this proposal are HH filers, who currently enjoy a standard deduction that is higher than that of a single filer as well as lower tax rates.

Personal Exemptions

Current Law: A deduction from adjusted gross income (AGI), called an exemption allowance, is permitted for the filer of the return, his or her spouse if filing jointly, and each dependent claimed on the return. For 2017, each exemption allowance is $4,050. So, for example, a married couple filing jointly with two dependent children would be entitled to an exemption allowance of $16,200. However, the exemption deduction phases out for higher-income taxpayers.

Proposed Law: Personal exemptions would be eliminated, but child and other dependent credits might take their place, as described later in this article.

Standard Deduction

Current Law: The standard deduction is for taxpayers without enough deductions to file a Schedule A and itemize their deductions. Currently a standard deduction is set for each filing status and is adjusted for inflation each year. For 2017, the standard deduction is $6,350 for single and married separate, $9,350 for head of household, and $12,700 for married joint and surviving spouse. There are also add-on amounts for each filer and spouse who is age 65 or over, plus an additional amount for blindness.

Proposed Law: The GOP’s framework would replace both the current standard deduction and the personal exemptions with new higher standard deductions. In addition, the proposal would do away with the additional standard deductions for the seniors and people with visual impairments.

When the proposed higher standard deductions were first announced some months ago, those using the standard deduction were excited to think their standard deductions would be roughly doubled. But now that we have a few more details, we find that personal exemptions would no longer be allowed, which changes the outcome significantly. The table below compares the current standard deduction and exemptions for different filing statuses and number of exemptions to the proposed standard deduction replacement.

As you can see, the proposed change favors the smaller family size, but this is supposed to be compensated for with a larger and partially refundable child tax credit that is discussed below.

Itemized Deductions

Current Law: Medical deductions are allowed to the extent that they exceed 10% of the taxpayer’s AGI, tax deductions for state and local (city) income taxes or sales tax, plus real and personal property taxes. Also included is interest paid on qualified first and second home mortgage acquisition and equity debt, provided the acquisition debt doesn’t exceed $1 million and the equity debt isn’t over $100,000. The debt amounts of the first and second homes are combined for this limitation. Other categories of itemized deduction are charitable contributions and miscellaneous itemized deductions.

Proposed Changes: The tax reform would eliminate all deductions except for charitable contributions and those that encourage home ownership, such as home mortgage interest.

There is already pushback from members of Congress whose constituents reside in states that impose an income tax on their residents. Taking away the ability to deduct state and local income tax, referred to as the SALT deduction, would most significantly impact taxpayers living in states that have income taxes, and thus they would be double-taxed on the same income. All but seven states have income tax, with California, New York and New Jersey imposing the highest rates.

Eliminating medical deductions will significantly impact senior citizens who require expensive elder care and taxpayers who incur extraordinary medical expenses.

Casualty, theft and disaster losses are currently included in itemized deductions, and the proposal is silent as to what will become of these all-important deductions. Also unaccounted for is the deduction for gambling losses, the elimination of which will force recreational gamblers to pay tax on all winnings even if they have a net loss.

Individual Tax Rates:

Current Law: There are seven tax rates (10%, 15%, 25%, 28%, 33%, 35% and 39.6%), with the tax progressively increasing as the taxpayer’s taxable income increases. Each tax rate is applied to ever-increasing ranges of taxable income, referred to as tax brackets, with the 2017 top brackets kicking in at $418,400 for single taxpayers and $470,700 for married taxpayers filing jointly.

Proposed Changes: The tax reform would reduce the number of tax rates to three: 12%, 25% and 35%, with possibly a fourth rate for the “highest-income” taxpayers. The proposal is silent as to the ranges of taxable income these rates will apply to, making it impossible to make comparisons between the current law and the proposed changes. However, should the three rates be made into law, the wealthiest taxpayers would enjoy a significant tax cut.

Child Tax Credit (CTC)

Current Law:  Allows a tax credit of $1,000 for each qualifying child dependent under the age of 17. The credit is generally nonrefundable (meaning it can only offset your tax liability and any excess is lost). However, when a taxpayer’s income is low or there are three or more qualifying children, a portion of the credit is refundable. The credit is also phased out for higher-income taxpayers.

Proposed Changes: The reform would increase the amount of the credit by an unspecified amount and make the first $1,000 of the CTC refundable. It would also add a nonrefundable credit of $500 for other dependents of the taxpayer that do not meet the child criteria. This presumably eliminates the current complicated calculation for the refundable portion of the child tax credit. The proposal intends that the income phaseout ranges be adjusted so more taxpayers will be eligible for the credit, but the higher phaseout levels are not specified. These adjustments to the CTC are touted to make up for the loss of personal exemptions, but without knowing the amount of the credit increase and the high-income phaseout ranges, it is impossible to make comparisons between the current and proposed regimes.

Alternative Minimum Tax (AMT)

Current Law: The AMT was originally initiated to keep higher-income taxpayers from benefiting from certain tax provisions. Over the years, inflation has caused the AMT to significantly impact more taxpayers than originally intended. Determining whether the AMT applies and computing the tax adds a layer of complexity to preparing the return.

Proposed Changes: The reform would eliminate the AMT.

Estate Tax

Current Law: The current code imposes a 40% tax on the estate of a decedent whose estate’s value exceeds $5.49 million. The $5.49 million is adjusted down for certain gifts made during the decedent’s lifetime. Beneficiaries of estates receive inheritances at the fair market value of the property inherited as of the decedent’s date of death. Thus beneficiaries who inherit property and then sell it are subject to tax only on the appreciation from the time they inherited the property.

Proposed Changes: The reform would eliminate the estate tax. Unanswered in the proposal is whether a beneficiary will continue to receive inherited property at fair market value or whether the heir will inherit the decedent’s basis in the property. If the latter, then when the beneficiary sells the property the beneficiary will be stuck with paying income tax on the entire appreciation in value from the time the property was acquired by the decedent. Also unanswered is whether the gift tax will continue to apply.

Top Tax Rate for Small Businesses

Current Law: At present, business income from a Schedule C, LLC, Partnership and S-Corporation is passed through to the owner of the business and included on his or her 1040 individual return and taxed at rates ranging rom 10% to 39.6%.

Proposed Changes: As mentioned previously, the proposed changes would reduce the current seven tax rates to three. For pass-through businesses, the proposed changes limit the tax on pass-through small business income to 25%, the middle rate of the three new proposed rates. Unfortunately, the term “small business” is not defined in the proposal. This proposed change would favor successful businesses that would otherwise be subject to the highest proposed tax rates.

Expensing Business Purchases

Current Law: Generally, capital purchases by a business, such as machinery, vehicles, or computer systems, must be depreciated (written off) over their useful lives—usually 3, 5 or 7 years for most purchases by small businesses. A special allowance, usually referred to as bonus depreciation, is available in the first year for certain types of property. There is also a provision that allows expensing up to $510,000 worth of purchases in lieu of depreciating the cost of the property.

Proposed Changes: The reform would allow 100% first-year expensing of capital purchases (other than structures) after September 27, 2017. The full expensing provision would not be permanent, but would be in the tax code for a minimum of five years. A future Congress could decide to extend the provision or make it permanent.

Other issues: Other issues generally not impacting small businesses or individuals include reducing the corporate tax rate to 20% – which is below the 22.5% average of the industrialized world – with the intent to make U.S. businesses more competitive with their foreign rivals. The corporate alternative minimum tax would also be eliminated. The proposed changes would also repeal the domestic production activities deduction and most business tax credits, except the low-income housing and the research and development credits.

The current consensus is that the changes, other than the business expensing, would not be effective until 2018. We hope this provides you with insight into the GOP’s proposed tax reform. But keep in mind that these proposals could, and probably will, change as the proposal works its way through Congress.

Tax Scams Reach All-Time High; Don’t Be a Victim

By Mike Jesowshek, CPA | Taxes

One thing we can count on when tax season begins is the scammers coming out from under their rocks with schemes to try and trick you so they can steal your ID and file returns under your Social Security number (SSN). Or, they may even email or call you pretending to be IRS or state tax agents and attempt to intimidate you into sending them money to pay fabricated tax liabilities. These crooks take advantage of individuals’ natural fear of the IRS and use it to coerce their marks into making payments without first verifying the validity of the liability.

Don’t be a victim of these unscrupulous predators. The only way to protect yourself is to understand their tricks and what to do (actually, what not to do). This article includes a variety of plots that have been employed in the past. But, keep in mind these lowlifes can be very clever, intimidating, and aggressive, and come up with new schemes all the time, so you need to be vigilant.

ID thieves prize three things: your name, Social Security number, and birth date. You should always be very careful about divulging your birth date and SSN. Don’t use them unless absolutely necessary, and always question the requester’s need to know.

You should also be aware that the IRS never initiates contact in any way other than by U.S. Mail. So, if you receive a phone call from out of the blue demanding payment, you can be assured it is a scam. Simply hang up the phone without providing any information. If you receive an email from the IRS, do not click on embedded links or attachments. That could cause malware to be installed on your computer, allowing scammers to access your computer. The first thing you should do is call this office.

Additionally, it is important for taxpayers to know that the IRS:

1. Never asks for credit card, debit card, or prepaid card information over the telephone.
2. Never insists that taxpayers use a specific payment method to pay tax obligations.
3. Never requests immediate payment over the telephone.
4. Will not take enforcement action immediately following a phone conversation. Taxpayers usually receive prior written notification of IRS enforcement actions involving IRS tax liens or levies.

Email Scams & Phishing – Every tax season, the scammers become very active. They create bogus emails disguised as authentic emails from the IRS, your bank, or your credit card company, none of which ever request information that way. They are trying to trick you into divulging personal and financial information that they can use to invade your bank accounts, make charges against your credit card, or pretend to be you to file phony tax returns or apply for loans or credit cards. Always be skeptical! If the email is related to taxes, call this office before doing anything. If it is supposedly from your credit card company, your bank, or another financial institution, call the organization to verify the authenticity of the email.

One scam last year was an email sent to taxpayers requesting that they click on a link in the email to verify their identity before their tax refund could be released. The link took them to the ID thief’s website, made to look like the IRS’s, where victims entered their names, SSNs, and birthdates. Others used the same scheme, pretending to be an individual’s bank or credit card company.

Phone Scams – Very aggressive scammers will call, claiming to be an IRS agent, and tell the person answering the call that they owe money that must be paid immediately or their home will be seized, their wages will be attached, or even that they will be arrested. After threatening the victim with jail time or driver’s license revocation, the scammer hangs up. Soon, someone else calls back pretending to be from the local police or DMV, and the (rigged) caller ID supports their claim.

These are frequently thieves from outside the U.S., and once the money is transferred, there is no chance of getting it back.

In 2016, the police in Mumbai, India, busted a phone center that was calling U.S. taxpayers with just such a scheme and bilking U.S. taxpayers to the tune of $150,000 a day. They demanded payment by credit card, debit card, or gift card.

ID Thieves – These rip-off artists file phony tax returns using stolen IDs and counterfeit W-2s and have the refunds directly deposited into their bank accounts, which they then clean out before the victim or the IRS discovers what happened. If the IRS rejects your return because a SSN on your return was previously used to file, that is a good indication your ID has been stolen, and you should contact this office for instructions on notifying the IRS. Once your ID has been compromised, the IRS will issue a special six-digit Identity Protection number that can be used in conjunction with your SSN to file your return.

If your ID has been compromised, or you suspect it might have been, contact this office immediately so we can assist you in notifying the IRS, so that they block returns filed with your SSN but without the special six-digit filing number.

We also urge you to educate others in your family who could be scammed.

If you have questions, please give this office a call.

When Business Meals and Entertainment Are Deductible

By Mike Jesowshek, CPA | Bookkeeping , Taxes

An often asked question is: are meals and entertainment deductible in the course of one’s business, and if so, under what circumstances? This type of expense requires you to comply with some pretty complicated qualifications, and if you can jump through the hoops, the expenses may be deductible in certain cases.

But before we go too far, know that unreimbursed meal expenses incurred while out of town overnight on business are always deductible but generally limited to 50% of the cost. The focus of this article is the deductibility of meals and attendance at events in the form of business entertainment.

The first hoop to jump through is meeting the “ordinary and necessary” requirement, which applies to all deductible expenses needed to carry on a business. Ordinary and necessary is broadly defined to mean customary or usual and appropriate or helpful.

The next hoop is meeting one of two tests: the “directly-related test” or the “associated-with test.”

• Directly-Related Test – In order to meet the directly-related test, the meal expense must be incurred in the active conduct of business and be for the taxpayer, business guest(s) and any spouse(s). Under the directly-related test, actual business discussions are required during the meal, and the taxpayer must show that he or she anticipated a specific business benefit from the meal, even if the benefit never materialized. Meetings or discussions that take place at sporting events, nightclubs, or cocktail parties – essentially, social events – wouldn’t meet this test.
• Associated-With Test – The associated-with test is somewhat more liberal, because it allows deductions for meal or entertainment expenses incurred the same day either directly preceding or following a substantial and bona fide business discussion. However, entertainment can still pass muster, even if it didn’t occur on the same day as the business meeting, if the facts and circumstances warranted a delay.

  Entertainment at shows, sporting events, night clubs, etc., can qualify under the associated-with test if its purpose is to get new business or encourage the furtherance of a business relationship. For meals, you or one of your employees must be present; otherwise, the expense is not deductible.

  If non-business guests are invited to an otherwise allowable “associated-with business” entertainment event, the expenses must be allocated between the business and nonbusiness guests. The expenses related to the non-business guests are nondeductible. However, the spouses of the taxpayer and of his or her business guests or associates are considered business guests for this purpose.

Still another hoop is the restriction for lavish expenses. Meal and entertainment expenses are deductible up to an amount not considered “lavish” (reasonable under the circumstances). Also, the taxpayer (or a representative of the taxpayer) must be present. The representative could be, for example, the taxpayer’s employee, an attorney or an independent contractor who performs significant services for the taxpayer.

The final hoop, which is as important as qualifying for the deduction, is meeting the substantiation requirements. You must be able to establish the amount spent, the time and place, the business purpose and the business relationship and names of the individuals involved. You should keep a diary, account book or similar records with this information and record the details within a short time of incurring the expenses – a timely kept record carries more weight in an IRS audit than one created months or years after the event occurred, when memory can be hazy. For expenses of $75 or more, documentary proof (receipts, etc.) is also required.

A final word: even after you have jumped through those hoops, in the majority of cases, only 50% of the qualified expenses are actually tax-deductible.

10 Financial Questions to Ask When Starting a Fitness Studio

By Mike Jesowshek, CPA | Bookkeeping , General Business , Payroll , Taxes

Starting up your fitness studio or gym is an exciting time, but it is also a time with many questions. While it may seem initially very easy to open a studio and start training, the financial aspects of being successful are a bit more challenging. As you consider the process of starting up, work with a accountant to ensure you get your financial footing in place now. Ask these questions.

#1: What should be in a basic business plan?

A business plan should outline each detail of your fitness studio including who will run it, how much you’ll charge, and what you expect to earn. Putting time into creating a thorough business plan is important. Work with your team to ensure your plan is accurate and represents your business well.

#2: Who will you need to pay taxes to?

Your local jurisdiction and state have specific taxation requirements. Youmay have to pay taxes on sales, but also costs associated with payroll. Ensure your accountant not only talks to you about who you need to pay, but payment deadlines as well.

#3: What is a projected cash flow for the fitness studio?

How much cash does your company need to keep on hand? The key here is to be able to anticipate how much it will cost you to operate your fitness studio. Many companies should not expect to have positive cash flow for at least a year, often longer. Your professionals can help you decide what your cash flow projections are.

#4: How much of an investment do you need to put into your fitness studio right now?

Your financial team can help you project the cost of setting up your new studio. This will include costs related to establishing the physical business and paying for equipment. Your initial investment generally will be the highest amount put into the company by the founder.

#5: What is your break-even analysis?

This may be an important question to ask early on. How much do you need to make to break even? You’ll want to talk to your financial team about the timeline for this and what can be done to help ensure you break even as soon as possible.

#6: What liability insurance do you need?

While most tax professionals don’t offer recommendations here, having adequate policies to cover potential loss is important. Work with your team to ensure you have comprehensive protection to minimize risks against your company’s financial health.

#7: What will interest cost you?

Interest on loans is not something to overlook. You’ll want to ensure you have an accurate representation of how much you are paying in interest so you can make adjustments to pay off any borrowed debt sooner, make better decisions about borrowing, or factor in the cost.

#8: How will you manage payroll?

This is a very big component of starting up since it can be troublesome for most startups to actually know how to pay employees and meet all federal and state requirements. Working with a payroll provider is often the easiest option (and most financially secure since paying an employee to do this work tends to be more expensive).

#9: How can you reduce your taxes?

Tax professionals will work with you to determine if there are any routes to reducing taxation on your business including local incentives that may be available. You’ll also want to talk about projects taxes, investments that could reduce taxes, and having all possible deductions in place.

#10: What’s the right profit margin/industry benchmarks?

Working with a financial team often comes down to this question. How much should you charge to make the best profit possible while still ensuring your company can grow? It’s not a simple question, but having the right team by your side ensures it will be clarified as much as possible.

Thinking of Tossing Old Tax Records? Read This First.

By Mike Jesowshek, CPA | Taxes

Now that your taxes have been completed for 2016, you are probably wondering which old records can be discarded. If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why the records must be kept in the first place.

Generally, we keep tax records for two basic reasons: (1) in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) to keep track of the tax basis of our capital assets so that the tax liability can be minimized when we dispose of them.

With certain exceptions, the statute for assessing additional taxes is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal law. In addition to lengthened state statutes that cloud the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return. And, of course, the statutes don’t begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return to evade taxes.

If an exception does not apply to you, for federal purposes, most of your tax records that are more than three years old can probably be discarded; add a year or so to that if you live in a state with a longer statute.

The big problem! The problem with the carte blanche discarding of records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. These need to be separated, and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

• Stock acquisition data – If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed to prove the amount of profit (or loss) you had on the sale.
• Stock and mutual fund statements (If you reinvest dividends) – Many taxpayers use the dividends they receive from stocks or mutual funds to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after the final sale.
• Tangible property purchase and improvement records – Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

For example, because of the generous $250,000 ($500,000 for joint filers) home gain exclusion available to most homeowners, some taxpayers have become lax in maintaining home improvement records, thinking the large exclusions will cover any potential appreciation in the home’s value. But that exclusion may not always be enough to cover sale gains, particularly in markets where property values have steadily risen, so records of home improvements are vital. Records can be important, so please use caution when discarding them.

If you sell securities (stocks, bonds or mutual funds) that result in a loss, after you’ve offset any capital gains from other sales, you may end up with a larger loss than can be deducted in one year (maximum $3,000 or $1,500 if married filing separate). In that case, you are allowed to carry over the excess loss to use in future years. When this happens, you will need to keep the purchase and sale records of the securities for four years after filing the return when the last of the carryover loss is used.

Similarly, if you have a net operating loss from your fitness studio or gym business that is being carried forward to future years, you’ll need to keep the business records from the loss year until four years after the return on which all of the loss was used up.

What about the tax returns themselves? While disposing of the backup documents used to prepare the returns can usually be done after the statutory period has expired, you may want to consider keeping a copy of your tax returns (the 1040 and attached schedules/statements plus your state return) indefinitely. If you don’t have room to keep a copy of the paper returns, digitizing them is an option.

If you have questions about whether or not to retain certain records, give this office a call first; it is better to check before discarding something that might be needed down the road.

Using Home Equity for Your Fitness Studio or Gym

By Mike Jesowshek, CPA | General Business , Taxes

Fitness studio and gym owners frequently find it difficult to obtain financing for their businesses without pledging their personal assets. With home mortgage interest rates at historic lows, tapping into your home equity is a tempting alternative but one with tax ramifications that should be carefully considered.

Generally, interest on debt used to acquire and operate your fitness studio is deductible against that business. However, depending upon the circumstances of the loan structure, debt secured by your home may be nondeductible, only partially deductible or wholly deductible against your business.

Home mortgage interest is limited to the interest on $1 million of acquisition debt and $100,000 of equity debt secured by a taxpayer’s primary residence and designated second home. The interest on the debts within these limits can only be treated as home mortgage interest and must be deducted as part of your itemized deductions. Only the excess can be deducted for your business, provided that the use of the funds can be traced to your business use. This creates a number of problems:

• Using the Standard Deduction – If you do not itemize your deductions, you will be unable to deduct the interest on the first $100,000 of the equity debt, which cannot be allocated to your business.
• Subject to the AMT – Even if you do itemize your deductions, if you happen to be subject to the alternative minimum tax (AMT), you still would not be able to deduct the first $100,000 of equity debt interest, since it is not allowed as a deduction for AMT purposes.
• Subject to Self-Employment (SE) Tax – Your self-employment tax (Social Security and Medicare) is based on the net profits from your business. If the net profit is higher, because not all of the interest is deductible by the business, your SE tax may also be higher.

  Example: Suppose the mortgage you incurred to purchase your home (acquisition debt) has a current balance of $165,000 and your home is worth $400,000. You need $150,000 to acquire or open a fitness studio or gym. To obtain the needed cash at the best interest rates, you decide to refinance your home mortgage for $315,000. The interest on this new loan will be allocated as follows:

  New Loan:	$ 315,000
  Part Representing Acquisition Debt	– 165,000	52.38%
  Balance	$ 150,000
  First $100,000 Treated as Home Equity Debt	– 100,000	31.75%
  Balance Traced to Business Use	$ 50,000	15.87%

  If the interest for the year on the refinanced debt was $10,000, then that interest would be deducted as follows:

  Itemized Deduction Regular Tax	$ 8,413	84.13%
  Itemized Deduction Alternative Minimum Tax	$ 5,238	52.38%
  Business Expense	$ 1,587	15.87%

There is a special tax election that allows you to treat any specified home loan as not secured by the home. If you file this election, then interest on the loan can no longer be deducted as home mortgage interest, since tax law requires that qualified home mortgage debt be secured by the home. However, this election would allow the normal interest tracing rules to apply to that unsecured debt. This might be a smart move if the entire proceeds were used for business and all of the interest expense could be treated as a business expense. However, if the loan were a mixed-use loan and part of it actually represented home debt (such as a refinanced home loan), then the part that represented the home debt could not be allocated back to the home, and the interest on that portion of the debt would become nondeductible and would provide no tax benefit.

As you can see, using equity from your home can create some complex tax situations. Please contact this office for assistance in determining the best solution for your particular tax situation.  We also have partnerships with multiple financing companies that focus on the fitness studio and gym industry, which may be a great alternative for funding.  Contact us to learn more about that as well.

Deducting Convention Expenses

By Mike Jesowshek, CPA | Taxes

As a fitness studio or gym owner you are always looking for new things you can implement in your business and there are tons of conference opportunities available.  Generally, an individual can deduct travel expenses from attending conventions, seminars or similar types of meetings within the North American area, provided that attendance benefits the taxpayer’s trade or business. However, family members’ travel expenses are not deductible, and neither are expenses from attending investment, political, social or other types of meetings not related to the taxpayer’s trade or business.

The North American area includes the United States, U.S. possessions, Canada, Mexico, Bermuda, Barbados, Costa Rica, Dominica, the Dominican Republic, Grenada, Guyana, Honduras, Jamaica, Saint Lucia, and Trinidad and Tobago. For a more detailed list, consult IRS Publication 463.

Thus, the entire cost of transportation and lodging, plus 50% of the meal expenses, is deductible for meetings held within the North American area.

Meetings Outside the North American Area – Deducting travel expenses for a convention or meeting outside the North American area has requirements:

• The meeting must be directly related to the taxpayer’s trade or business (whereas meetings within the North American area need only benefit the taxpayer’s trade or business), and
• It must be reasonable to hold the meeting outside the North American area. There is no specific definition of “reasonable” for this purpose, which places the burden of proof on the taxpayer. Considerations include the meeting’s purpose and activities and the location of the meeting sponsors’ homes.

Even if the above requirements are met, the amount of deduction allowed depends upon the primary purpose of the trip and on the time spent on nonbusiness activities:

Meetings Held on Cruise Ships – When a convention or meeting is held on a cruise ship and is directly related to a taxpayer’s trade or business, the taxpayer is limited to $2,000 per year in deductions for expenses from attending such conventions, seminars, or similar meetings. All ships that sail are considered cruise ships. The following rules also apply:

• The cruise ship must be registered in the United States.
• All of the cruise ship’s ports of call must be in the United States or its possessions.

If you have questions related to the deductibility of expenses from conventions and meetings or from foreign travel, please give this office a call.