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Tax Essentials for Small Business Owners

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Expert: Edward S. Karl
Tax Essentials for Small Business Owners

Edward S. Karl

Vice President of Taxation for the American Institute of Certified Public Accountants (AICPA)

Thursday, December 15, 2011 11:00 PM

Edward S. Karl, CPA, is vice president of Taxation for the American Institute of Certified Public Accountants (AICPA). He is responsible for the review, formulation, and submission to Congress, the Treasury Department, and the Internal Revenue Service of technical and policy recommendations for improvement of the federal tax process. Karl serves as a principal liaison for the AICPA with the Internal Revenue Service. He is also responsible for tax ethical issues including management of the AICPA's tax standards, the Statements on Standards for Tax Services. Karl also oversees the Tax Division's delivery of services to members which focuses on helping AICPA members provide the highest quality professional tax services.

Karl was previously employed in the tax department of a large, national CPA firm where he established their tax department. He was a frequent contributor to The Certificate, a publication of the Greater Washington Society of CPAs, of which he was an editor for fifteen years. He has also spoken at numerous tax institutes, state CPA society meetings and IRS programs.

Karl is a member of the AICPA, the American Society of Association Executives, the Maryland Association of CPAs, and the Greater Washington Society of CPAs where he has also served on their Federal Tax Committee and Board of Governors.

With tax season around the corner, small business owners can prepare now with useful end of year tax tips. Join SBA and the AICPA web chat by posting your questions about year-end tax savings to help you prepare for the coming tax filing season. Participants can learn more about tax deductions and credits they can use to reduce their taxes, as well as other tax savings tips.

A live Q&A session with small business experts. Submit your question before or during the chat discussion. You cannot submit question after Closing Remarks for the chat. No registration is needed for the web chat. With tax season around the corner, small business owners can prepare now with useful end of year tax tips. Join SBA and the AICPA web chat by posting your questions about year-end tax savings to help you prepare for the coming tax filing season. Participants can learn more about tax deductions and credits they can use to reduce their taxes, as well as other tax savings tips.

Note: There is no audio connection to web chat, and no broadcast capability. SBA moderators retain editorial control over the online discussions and choose the most relevant questions for chat participants. SBA chat hosts may decline to answer questions.

Note from the AICPA: We are providing answers in the context of a web chat, without having full knowledge of all details of the taxpayer's circumstances or the opportunity to conduct in-depth research. The AICPA and its employees cannot assume liability for tax advice being given in this web chat. Before acting on any advice provide here, you should consult a CPA or other competent tax professional. Also, we are required by the IRS to provide the following notice: any tax information in this web chat is not intended to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions.

Chat Transcript

 
From:
Britt Travis
Location:
Charleston, Sc
 

Welcome to this year’s SBA Web Chat: Tax Essentials for Small Business Owners. AICPA is pleased to participate and we hope our responses will be useful to you. Tax, financial and business planning is a year round venture so we would also encourage you to seek competent advice throughout the year and not just at year end. I truly believe that proper planning will give you a leg up on success. 

The questions we’ve already received were quite thoughtful so we’re looking forward to an interesting chat. Again, welcome!
            Edward Karl, CPA, AICPA VP Taxation
 
From:
Britt Travis
Location:
Charleston, Sc
 
Question:
What bills / expenses should I pay for my home based business with my business bank account
Reply:
I would recommend that you pay expenses directly related to your business (such as a business phone, supplies, business equipment, etc.) with your business bank account. I would pay for expenses related to the upkeep of the home with a personal bank account. Even if you pay for certain home expenses with a personal bank account, you may be able to deduct a portion of them for income tax purposes if they are indirectly related to your business. Examples of these types of expenses include insurance, utilities and general repairs. If you qualify for a home deduction, these expenses are deductible based on the percentage of your home used for business purposes. You may want to check out IRS Publication 587 for more information on whether you qualify for a home office deduction and the types of expenses you can deduct.
 
From:
ALVARO PATINO
Location:
CORAL SPRINGS, FLORIDA
 
Question:
HOW REGISTER A LLC IN USA, IF THE MEMBERS ARE FOREING PEOPLE?
Reply:
An LLC is a state-law entity and therefore is governed by the differing laws of each state. If, by foreign, you mean, a resident of a foreign country, than it is unlikely you will be able to register as an LLC in one of the United States. Generally states define a domestic LLC as being comprised of members resident in that state. Residents of other states are “foreign” LLCs. If a business is operating in the US, but is organized in another country, than the laws of that country will govern the formation of the entity.
 
From:
Bob Aukerman
Location:
,
 
Question:
This is the first year I own an S corporation. I want to minimize payroll taxes. Is there some written guidance that indicates the minimum amount of salary I can take? Is there some bright line test or if not what factors does the IRS consider?
Reply:
There are no bright lines. Your compensation must be reasonable for the amount and type of work/services your perform. See http://www.irs.gov/newsroom/article/0,,id=200293,00.html See also http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newsletters/Articles_2008/CorpTax/Corporation_Officers.jsp and http://www.groco.com/readingroom/bus_scorp_shareholders.aspx
 
From:
Dan Deyton
Location:
Daphne, Al
 
Question:
What expenses can be deducted when buying a new computer. Going from a PC to a Mac is a sizable learning curve. If you have to travel to a training center for classes is that deductible ? Also if you have a home office is installing service ie AT&T deductible ?
Reply:
For all your questions, we are assuming you are self-employed. If all the purchases/expenses are for personal use, there is no deduction available. You can claim a tax deduction for the purchase of the computer if the computer is exclusively for business use. Depending on the size of the purchase, you can amortize, depreciate or fully deduct the purchase. The travel to training and the training costs are deductible if the training is related to your job, or to improve your skills. Assuming your home office qualifies for the home office deduction, most home offices do not – see Internal Revenue Code 280 A, you can deduct a portion or all, if the AT&T service is exclusively for business use, of the expense to install the service. Please consult your CPA for further details and to determine the best and most appropriate way to deduct your expenses.
 
From:
Dan Deyton
Location:
Daphne, Al
 
Question:
What expenses can be deducted when buying a new computer. Going from a PC to a Mac is a sizable learning curve. If you have to travel to a training center for classes is that deductible ? Also if you have a home office is installing service ie AT&T deductible ?
Reply:
For all your questions, we are assuming you are self-employed. If all the purchases/expenses are for personal use, there is no deduction available. You can claim a tax deduction for the purchase of the computer if the computer is exclusively for business use. Depending on the size of the purchase, you can amortize, depreciate or fully deduct the purchase. The travel to training and the training costs are deductible if the training is related to your job, or to improve your skills. Assuming your home office qualifies for the home office deduction, most home offices do not – see Internal Revenue Code 280 A, you can deduct a portion or all, if the AT&T service is exclusively for business use, of the expense to install the service. Please consult your CPA for further details and to determine the best and most appropriate way to deduct your expenses.
 
From:
James Fahrner
Location:
Plymouth, MI
 
Question:
if you company has losses should you still fill out the R&D credit form to establish abase line?
Reply:
Keep in mind that the credit for increasing research activities (Form 6765) is a nonrefundable credit. However, it can be used to offset both regular taxable income and alternative taxable income. As part of the general business credit, it also can generally be carried back one year and carried forward twenty years. There are several possible ways to compute the credit, with some changes in the past few years. The credit is an area that the IRS will examine if your income tax return is chosen for audit. As such, keeping good records and substantiating the qualification for the credit are extremely important. So even if your company has a loss for regular tax purposes in the current year, it may potentially be able to use the research credit for AMT purposes, or possibly carry it back or forward to other years.
 
From:
Steve Volz
Location:
Milwaukee, Wi
 
Question:
Please explain the risk to a small business(C Corp.) that is considering in lieu of paying a salary to its owner(and only employee) a commission instead that would be reported on a from 1099. The owner would then pay the self employment tax and income tax on this amount on his personal individual return. We are aware of the risk of potential state and federal unemployment taxes and workers compensation issues, are there any other risks with this type of treatment?
Reply:
Those appear to be the risks. If you classify someone as an independent contractor and not as an employee, you may be held liable for employment taxes (Social Security and Medicare taxes) for that worker. The IRS is auditing and has a special compliance initiative underway regarding employee (W-2) versus independent contractor (Form 1099). The IRS has some info: at http://www.irs.gov/businesses/small/article/0,,id=99921,00.html
 
From:
Chase
Location:
,
 
Question:
ABC,LLC is in bankruptcy and owes a note to XYZ,LLC. ABC,LLC has been notified & awarded by a fed court that XYZ,LLC is to be paid their note. ABC's money is in escrow with the court because another party is contesting the fed courts ruling in a lower court. ABC's lawyers believe its highly likely the ruling will be uphelp. If ABC,LLC is an accrual taxpayer, can they accrue the payoff to XYZ and write-off for 2011 taxes?
Reply:
The accrual method generally permits deductions for tax purposes in the year that: 1) all events have occurred to establish the fact of the liability; 2) the amount can be determined with reasonable accuracy; and, 3) economic performance has occurred. Some other limitations may apply (for example, if an item is required to be capitalized, rather than deducted). You should evaluate your fact pattern against all of the rules to determine proper year of deduction. However, the main focus laid out in your question is whether the all events test (as laid out at 1) and 2) above) has been met at tax year end. You and your tax advisor should look to the various rulings and case law in the area and evaluate it in relationship to your specific factual situation.
 
From:
Mary David
Location:
Marietta, GA
 
Question:
What would you say are the true related expenses for harvesting lumber?
Reply:
Many of the general rules regarding deductible and capitalizable (with depreciation) expenditures apply to timber, but there also are some unique rules for timber as well. Check out IRS Publications 225, 535, 544, and Form T. Some potential timber expenditures include the costs of logging the timber, any necessary road construction, drainage structures, conducted management activities on fee land, depletion, etc. Your CPA will be able to discuss the rules with you and your specific facts to make sure you are claiming the appropriate deductions.
 
From:
Elaine Concklin
Location:
Houston, Texas
 
Question:
How many years can a schedule C Sole proprietor show a loss before IRS disallows the loss and declares the business a hobby. For example, my husband has a small business and he has been buying equipment for his business and showed a loss for the first several years due to accellerated depreciation. He has not been deducting legitimate expenses for fear of showing too many losses and triggering IRS scrutiny. We forced a small gain for his 2010 return, losing out on legitimate deductions. Since I work, we don't depend on his business to pay the mortgage although I would like him to make more money. :-) His business is also affected by the weather and although, he works as much as possible, he is greatly dependent on the weather. Any advice? Thank You.
Reply:
Generally, there are two ways to avoid the hobby loss rules. The first way is to show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing, or racing horses). The second way is to run the venture in such a way as to show that you intend to turn it into a profit-maker, rather than operate it as a mere hobby. How can you prove that you have a profit-making objective? In general, you can do so by running the business in a businesslike manner. More specifically, IRS will look to the following factors: how you run the activity; your expertise in the area; the time and effort you expend in the enterprise; whether there's an expectation that the assets used in the activity will rise in value; your success in carrying on other similar activities; your history of income or loss in the activity; the amount of occasional profits (if any) that are earned; your financial status; and whether the activity involves elements of personal pleasure or recreation. I hope the weather holds up for your husband’s business!
 
From:
I. Hoffman
Location:
Santa Barbara, CA
 
Question:
I run a design studio as a sole proprietorship. I rent an office in a great part of won, but it's on the lower ground floor and I have no windows. So, to compensate (and avoid seasonal affective disorder), I work at least 2 days a week from home, where I've also set up a desk, printer, etc. Can I claim a percentage of my home rent as a tax deduction?
Reply:
Yes, you can claim part of your home office expenses (including rent) that you use for business purposes if you meet certain criteria. You could deduct a percentage of many of the actual costs of running your home, such as utilities, rent, insurance, depreciation, home insurance, mortgage interest, real estate taxes, and some casualty losses, repairs, and improvements (if they relate to the part of the house you use for business). More info from the IRS is available at http://www.irs.gov/newsroom/article/0,,id=108138,00.html and from the SBA at http://www.sba.gov/content/small-business-expenses-and-tax-deductions
 
From:
ARG
Location:
Dayton, OH
 
Question:
I own and operate a small, home based business and want to ensure I have all the bases covered come tax time. What are some tips, and or is there a home-based biz tax checklist that can help?
Reply:
Generally, there are two types of deductible expenses. First, there are expenses which are directly related to your business. Examples of direct expenses include business phone, supplies, and business equipment. There are also expenses which are indirectly related to your business. Examples of indirect expenses may include insurance, utilities and repairs. These expenses are generally deductible based on the percentage of your home used for business. You may want to review IRS Publication 587 (http://www.irs.gov/pub/irs-pdf/p587.pdf) for examples of additional home office expenses. Page 8 and 9 list quite a few.
 
From:
Mohamed Saleh, MD
Location:
Jacksonville, Florida
 
Question:
I am in the process of opening a Day Spa and hair Salon, Is it better to have sub-tenants that rent the various stations, Independent contractors or emploees, paid a salay oe small salary plus commission?
Reply:
The question is not whether it is better to have independent contractors or employees for tax purposes, but rather what is the relationship between you and the workers? Will you provide them supplies – such as combs, scissors, shampoo, etc.? Will they use the same telephone as your business? Will they use the same receptionist? How much control as employer will you have over how they perform services? The question of whether a worker is an independent contractor or employee for federal income and employment tax purposes is a complex one. It is intensely factual, and the stakes can be very high. If a worker is an employee, there may be state tax obligations as well. Unfortunately, there is no uniform definition of the term “employee.” Under the rules developed by the courts, a worker generally is an employee for federal tax purposes if the employer has the right to control and direct the worker regarding the job he is to do and how he is to do it. The employer doesn't actually have to direct or control how the services are performed; it's enough if the employer has the right to do so. IRS usually applies the following factors to see if the employer has the right to direct and control the worker: • A worker who must comply with instructions about when, where, and how he or she is to work is ordinarily an employee. • Training a worker by teaming an experienced employee with the worker or requiring him or her to attend meetings, indicates the business wants the services performed in a particular manner. • A business that hires, supervises, and pays assistants for a worker is exhibiting employer-like control over the worker on the job. Conversely, an independent contractor relationship is indicated if a worker is contractually obligated to hire, supervise, and pay assistants. • The fact that a business requires work to be performed on its premises suggests control over the worker (if the work could be done elsewhere). Work done off the premises, such as at the worker's office, indicates some freedom from control. • A business exhibits control over a worker if it requires him or her to perform services in a specific order or sequence. • Payment by the hour, week, or month generally points to an employer-employee relationship, if this method of payment isn't just a convenient way of paying a lump-sum agreed upon as the cost of a job. Payment by the job or on a straight commission basis generally indicates a worker is an independent contractor. • A business exhibits characteristics of an employer if it supplies a worker with significant tools, materials, and other equipment, or ordinarily pays the worker's business and/or traveling expenses. • A worker exhibits independent contractor status if he or she invests in facilities that aren't typically maintained by employees (e.g., renting his or her own office). By contrast, an employee usually relies on the employer to provide the facilities needed to do the job. • A worker who can realize a profit or suffer a loss as a result of his or her services generally is an independent contractor, but a worker who can't is an employee. The risk that a worker won't be paid isn't factored in. • A worker who performs more than minimal services for a number of unrelated businesses at the same time generally is an independent contractor. However, a person who works for more than one business may be an employee of each business, especially where the businesses are part of the same service arrangement. • The right to fire a worker is a factor indicating that he or she is an employee. An independent contractor, on the other hand, can't be fired as long as he or she produces the work that was contracted for. I realize this is a lot of information. Hopefully, it is not too overwhelming. My best advice is, if you are in doubt, treat the workers as employees.
 
From:
J. BECKER
Location:
,
 
Question:
N
Reply:
A question was not received.
 
From:
Joe Tureix
Location:
Lakewood, CO
 
Question:
How do you write of real estatre losses? I sold my house for 42K below what I bought it for.
Reply:
I am sorry to hear about the loss on the sale of your home. Unfortunately, you cannot take a deduction for personal losses. You may need to report the sale on your personal income tax return on Schedule D – but there will not be any tax consequences to the transaction.
 
From:
Chip Erwin
Location:
Omaha, Nebraska
 
Question:
I sublet a furnished apartment and have furniture to depreciate, lease expenses and utilities expenses. How would I show these on my taxes along with the income produced from subletting the apartment? Thank you in advance, Chip Erwin
Reply:
Generally, cash or the fair market value of property you receive for the use of real estate or personal property is taxable to you as rental income. You can generally deduct expenses of renting property from your rental income. Income and expenses related to real estate rentals are usually reported on Form 1040, Schedule E. If you provide substantial services that are primarily for your tenant's convenience, you report your income and expenses on Form 1040, Schedule C.
 
From:
Michael Larkin
Location:
Marietta, GA
 
Question:
n/a?
Reply:
A question was not received.
 
From:
Arletha Blackman
Location:
Sarasota, FL
 
Question:
I have a Staffing and Recruiting Company based out of my home with a dedicated office space there. Also used have a few 1099 and w-2 employees/contractors on my payroll during 2011. What tax write-off are available and other saving tips you can provide?
Reply:
Reply: : You can deduct various home office expenses if you meet the requirements. You could deduct a percentage of many of the actual costs of running your home, such as utilities, rent, insurance, depreciation, home insurance, mortgage interest, real estate taxes, and some casualty losses, repairs, and improvements (if they relate to the part of the house you use for business). You could also deduct ordinary and necessary business expenses that you incur at home -- for instance, long-distance phone calls, a separate business telephone line, and the cost of office supplies and equipment. Other possible deductible expenses items include travel costs associated with business, in addition to meals, entertainment and gifts, subject to certain limitations. Also, if you use your car in your business, you can deduct certain car expenses. Other possible deductible business expenses may include: wages paid,business interest expense, retirement plan contributions, rent expenses, taxes, insurance, and business related education. More info from the IRS is available at http://www.irs.gov/newsroom/article/0,,id=108138,00.html and from the SBA at http://www.sba.gov/content/small-business-expenses-and-tax-deductions
 
From:
Daniel
Location:
Miami, FL
 
Question:
Just wanted to know what to deduct on my taxes this coming year
Reply:
Daniel – Well, you will first need to determine if you are taking the standard deduction or itemizing your deductions. Then, you can review the Form 1040 instructions to determine which deductions and credits are applicable to you. Generally, the tax rules for 2011 are similar to 2010. The biggest change from last year was the Making Work Pay Credit, which expired at the end of 2010. Ed
 
From:
R QUINNIE
Location:
SAN JACINTO, CA
 
Question:
HOW CAN I GET A FEDERAL AND STATE TAX ID NO? I AM SELF EMPLOYED. I MAKE JEWELRY AT HOME TO SELL WHOLESALE AND RETAIL? I HAVE A RESALE LISCENSE DO I NEED A STATE LISCENSE?
Reply:
To obtain a Federal Tax Identification Number visit the IRS website at: http://www.irs.gov/businesses/small/article/0,,id=98350,00.html Assuming you are a California resident, to obtain a California Tax Identification Number visit the state of California website at: http://www.taxes.ca.gov/doingbus3.shtml Both websites have links that explain if you need a tax identification number, how to get a tax identification number and links to apply for the identification number. Please consult your CPA to discuss in detail how you are doing business, which might involve other states and their licensing requirements.
 
From:
willy Revilla
Location:
Gaithersburg, Maryland
 
Question:
I am trying to have a tax ID number for a new bussiness that i whant to have. my questions are: - Do i need to have a trade name first than a tax ID number? - what form i need to have in oder to have a Business tax ID number and where do i need to send the form?
Reply:
Hello Willy, thank you for your question. To obtain a Federal Tax Identification Number visit the IRS website at: http://www.irs.gov/businesses/small/article/0,,id=98350,00.html The website has links that explain if you need a tax identification number, how to get a tax identification number and links to apply for the identification number on-line. There are also links that explain how to apply for the Federal Tax Identification Number through phone, mail or fax. You do not need to have a trade name to get your tax ID number. Please consult your local CPA to discuss in detail how you are doing business, which might involve other states and their licensing requirements.
 
From:
John Kleppinger
Location:
Bethlehem, PA
 
Question:
I work from home occasionally outside of my office. Any write-off potential for my home expenses? Does it matter if I rent?
Reply:
Hi John, It is possible to deduct a portion of your expenses for working from home on Schedule A, subject to the 2% AGI limit, as unreimbursed employee expenses. However, to qualify for this deduction, the home office, or part of your home, should be used regularly (not occasionally) and exclusively for business. Any personal use of the space, no matter how small, means the exclusive use test is failed. The expenses must have been paid or incurred during the tax year, for carrying on business of being an employee and must be ordinary and necessary. The deduction is available regardless of owning or renting your home.
 
From:
Wanda Johnson
Location:
Cedar Rapids, IA
 
Question:
Can you submit your personal taxes first then do an amended for your business part once you have collected all the paperwork before April 15th or do you have to do it all at the same time?
Reply:
Hi Wanda, You don’t indicate what the “business part” of your Form 1040 involves. It could potentially be a Schedule C, Schedule E, Schedule F, or the flow through of various income and deduction items from a partnership or S-corporation Schedule K-1. Usually each of these types of business operations are a significant portion of an individual’s return and can drastically impact the total taxable income and federal income tax on the return. If you are expecting to receive the information before April 15th, it would typically be recommended to wait to file until you can include all information properly within your Form 1040. Keep in mind that if the information is not expected to be available by April 15th, you should be able to request an extension for filing your individual income tax return. However, the extension of time to file does not permit you an extension of time to pay any tax owed. Thus, a good estimate of the income from the business operations should be included in determining your taxable income and federal income tax at the time of preparation of any extension to file request. If you have not paid sufficient tax quarterly throughout the year and/or by the April 15th original due date of the return, you may be subject to various late payment penalties and interest. Talk to your tax preparer about your situation and when you anticipate information to become available so you can determine the best plan for you regarding the preparation and filing of your Form 1040.
 
From:
eloise v. lewis
Location:
Honolulu, Hawaii
 
Question:
Are tax laws for SBA's in Hawaii the same as for the mainland states?
Reply:
Hi Eloise – I was just in Hawaii a few weeks ago for a tax conference – what a beautiful place to visit! I climbed Diamond Head and very much enjoyed the warm weather. My best advice to you is to consult with a local CPA. The laws are very different in Hawaii and can be challenging for many small businesses. One of my staff members worked in Hawaii for a few years and specialized in state and local taxes. She particularly cautioned me that the general excise tax has many exemptions that even the largest businesses are not aware of. In order to avoid overpaying your taxes and make certain you properly reporting everything, you would want to talk to someone local. Aloha! Ed
 
From:
Michael Gamet
Location:
La Habra, CA
 
Question:
I have start up costs of my new business this year but my business will open next year 2012. What are my options for writing off expenses in the year of my projected income?
Reply:
Determining the proper year in which to start to claim deductions associated with start-up costs is a facts and circumstances determination. But typically, taxpayers are not permitted any deduction for start-up costs until the year in which the active trade or business begins. You need to look to what activities have occurred in 2011, and what activities will occur in 2012 to determine that proper year. In general, Internal Revenue Code section 195 permits electing taxpayers to claim a deduction for the tax year in which its active trade or business begins in an amount equal to the lesser of 1) the amount of start-up costs for the active trade or business or 2) $5,000 (reduced by the amount by which the start-up costs exceed $50,000. Where the election is made, the remainder of the start-up costs are deductible ratably over a 180 month period beginning with the month in which the active trade or business begins. Distinction with IRC Section 248 regarding organization costs. Also see IRC Section 709 re partnerships. Final regulations on Sections 195, 248 and 709 were issued this past summer, so also look to those for additional guidance.
 
From:
Victor
Location:
Jacksonville, FL
 
Question:
Is there a mathematical rule of thumb when a single person C-corp should pay herself salary instead of dividends to reduce taxes?
Reply:
Victor, C-corporations pay tax, and individuals pay tax as well - thus the double level of tax. The individual should generally claim a reasonable salary for the work performed for the C-corp., as this may be questioned by the IRS on examination. Keep in mind that salary is subject to payroll taxes (such as FICA). So if you claim little or no salary, you will not be earning points towards social security benefits when you retire. In evaluating the appropriateness of any salary amount, most also consider the anticipated total income from the company, what other companies that are similar are paying the salaries for their officers or similar employees, as well as the income tax rates that the individual and the C-corporation are subject to.
 
From:
Dave Alberty
Location:
,
 
Question:
Any expiring tax provisions that the speakers feel will not be renewed and therefore should not be counted on for planning purposes?
Reply:
As you may have heard, the payroll tax cut expires at the end of this year if it is not extended by Congress. Other provisions that expire at the end of 2011 include: the enhanced credit for health insurance costs of eligible individuals, the first-time homebuyer credit for individuals on qualified official extended duty outside the United States, credit for certain nonbusiness energy property, personal tax credits allowed against regular tax and AMT, tax credit for research and experimentation expenses, credit for energy efficient appliances, increased AMT exemption amount, deduction for certain expenses of elementary and secondary school teachers, increase in expensing to $500,000/$2,000,000 and expansion of definition of section 179 property, above-the-line deduction for qualified tuition and related expenses, tax-free distributions from individual retirement plans for charitable purposes, expansion of adoption credit and adoption assistance programs, conversion credit for plug-in electric vehicles, and credit for electric drive motorcycles/threewheeled vehicles/and low-speed vehicles. A full list is available at http://www.jct.gov/publications.html?func=startdown&id=3722
 
From:
Enrique Gandarilla
Location:
Chula Vista, California
 
Question:
My wife and I started a home-based business last October. It is a partnership (just the two us). Is the income generated by the partnership taxable if it remains within the partnership and not distributed to the partners? We filed a partnership tax return last year and we did not owe any taxes. The partnership income was under 100K.
Reply:
Yes. The whole tax point of a partnership or an S corporation is to pass-through business income to the owners. That doesn’t mean you only pay taxes when earnings are distributed, but you pay when earned. Therefore you are responsible for quarterly estimated payments as well as payment of any remainder due on your 1040. Unfortunately, there is no minimum taxable income level. Even $1 of business income must be reported and taxes paid accordingly.
 
From:
Terry Peterson
Location:
Woodhaven Queens, New York
 
Question:
My accountant has my company listed as an S Corp. I get orders from my Clients all businesses (no retail) and non-Profits for bulk orders of mattresses as purchase orders. I send the order to the vendor and an independant contractor delivers direct I bill 30 day net. I have no showroom,warehouse or employess, just me. Do I need to keep paying Unemployment insurance/payroll tax/workers comp ???
Reply:
First, you should have worked with your accountant to decide on your choice of entity. If you are an S corp, than you are a separate legal corporate entity and services performed by you or others are generally treated as services performed by an employee. The owner of an S corp who works in the business must pay him or herself a salary/wage that is reasonable based on numerous marketplace factors. As an employee, payroll taxes, worker’s comp and unemployment insurance are all required.
 
From:
Edyth Leah Conklin
Location:
Highland,, New York, 12528
 
Question:
I would like to know if you sell things on line and you don't sell anything why to you pay taxes on nothing sold. I have had a jewelry business online for 6 years and never sold anything.
Reply:
Edyth, if you have no income to report, you shouldn't be paying additional taxes. However, there could be a problem with deducting expenses when you've never had any income. Internal Revenue Code Section 183 (Activities Not Engaged in for Profit) limits deductions that can be claimed when an activity is not engaged in for profit. IRC 183 is sometimes referred to as the “hobby loss rule.”
 
From:
Mufid Abu-Zahra
Location:
Bloomfield Hills, MI,
 
Question:
I did incorporate as an S corporation last year. Last year income is zero, This year income is approximatly 30,000. and next year 110,000. I am an engineering consultant. I would like to minimize my individual income from the corporation. I also would like to maximize my corporate pre-tax saving. Qustions are: 1) what is the maximum corporate pre tax saving i can utilize i.e SEP-IRA 2) what is the % minimum income from corporate income after expenses which I can distribute as individual income 3) recomended tax software to use, books, internet info....etc Thanks
Reply:
My understanding of SEP-IRA rules are that, in general, you can defer and deduct 25% of your salary, up to the [$16,500 for 2011] defined contribution (401(k)) limit. There are other rules, such as anti-discrimintation rules if you have employees, and others that need to be considered, but that is the general rule. As to your second question, there is not really a minimum distribution percentage, but bear in mind, you pay tax on the S corporations earnings, whether or not you distribute those profits. You must make quarterly estimated payments on Form 1040-ES based on the corporation's earnings. But, as to distributions, you must pay yourself a salary commensurate with the value of your services as an employee of the corporation. This salary must be reported on a W-2 and you must pay employment taxes, unemployment insurance and [most likely, depending on the state] worker's comp. Any earnings which you can reasonable attribute to something beyond your personal services don't have to be paid out as salary, but are taxed as earned and become part of the quarterly estimate. The salary portion is not a part of the quarterly estimate, assuming you are properly withholding and remitting payroll taxes. Given the service nature of your business, I would think a majority is due to salary. It is very hard to recommend software, etc in this capacity.
 
From:
J. Paul Dhillon
Location:
Pittsford, NY
 
Question:
I have been using old fashioned type writer to prepare my 1098 and 1099 forms. Is there an easy way of preparing these forms on line at low or no cost? Paul
Reply:
Hi Paul - I understand your concern about preparing the 1099s. I understand there is an on-line program called the Returns Electronically System (FIRE System); however, you cannot use it unless you have software that can produce a file in the proper format. It does not have a fill-in format. Otherwise, you may need to check with your CPA as to whether they offer this particular service. Unfortunately, I am not aware of any other method. Ed
 
From:
Marylou Denyer
Location:
Canoga Park, California
 
Question:
Where can I find information on sales tax for the individual states? Thank you.
Reply:
Try this: http://www.zip2tax.com//z2t_services.asp#PageSection1
 
From:
Brett
Location:
,
 
Question:
If an inventory-less business is upside down, with payables doubling receivables, but they have been filing on cash basis, is there any way they can switch to an accrual system or otherwise seek to expense those payables in the current year?
Reply:
Thanks for the question Brett. You don't indicate if the business is a Schedule C sole proprietorship, C-Corporation, S-Corporation, Partnership, etc. But it generally doesn't make much difference. Once a taxpayer has adopted an overall method of accounting for tax purposes (such as the cash method), the taxpayer must continue to use it until they request and receive IRS permission to change to another tax method (such as accrual). This is typically done by requesting permission on Form 3115. However, such request may be subject to different rules and due dates depending on your specific facts - some are what the IRS considers automatic and others require prior approval. Some taxpayers who would like to change from cash to accrual may potentially be able to file under Revenue Procedure 2011-14 (as modified), while others may have to request prior approval under Revenue Procedure 97-27 (as modified). The rules can be very detailed and confusing. Your CPA can help you work through your facts and determine how you may be able to change from cash to accrual.
 
From:
Cynthia Hartley
Location:
Washington, DC
 
Question:
I just registered my LLC this year as a first step to getting my business started. I also purchased some equipment - laptop and printer - and took a small business class. Can I write these expenses off even though I've not yet generated any revenue?
Reply:
Hello Cynthia. Thank you for your question. A great majority of start-up's have expenses before they can generate any revenue. You can claim a tax deduction for the purchase of the laptop and printer if the equipment is exclusively for business use. Depending on the size of the purchase, you can amortize, depreciate or fully deduct the purchase. The travel to your business class and the class costs are deductible if they are related to your job, or to improve your skills. Please consult your CPA for further specifics about your situation and to determine the best and most appropriate way to deduct your expenses.
 
From:
J. Paul Dhillon
Location:
Pittsford, NY
 
Question:
I have been using old fashioned type writer to prepare my 1098 and 1099 forms. Is there an easy way of preparing these forms on line at low or no cost? Paul
Reply:
Hi Paul – I understand your concern about filing 1099s. It is my understanding there is an on-line system called Returns Electronically System (FIRE System). However, the software requires you to have software that can produce a file in the proper format. There is no fill-in form option for reporting through this system. You may want to check with your CPA as to whether or not they provide this service. Otherwise, I would recommend that you hang on to your old fashioned type writer for now. Ed
 
From:
Lisa Harbert
Location:
Seattle, WA
 
Question:
I started a PLLC and got a letter from the IRS saying I should file forms 8832 and 2553. Can you explain these?
Reply:
Lisa, Form 8832 is an entity classification election when you want to operate in a form other than the "default" form. For example, if your LLC has only only one member, it would default as a sole proprietorship and you would be required to file scheduled C with your Form 1040. If your LLC has two members, it defaults as a partnership and you are required to file Form 1065. If, as an LLC, you would like to be treated as an S corporation for federal tax purposes, you must first file the 8832 and elect to be treated as a corporation, then you must also file the 2553 to then be treated as an S corporation.
 
From:
Gayle Isono
Location:
Mililani, Hawaii
 
Question:
I started my own promotional products distributorship in February 2011. Work from home office. Wondering what deductions I can take to reduce my tax liability.
Reply:
Gayle, Congratulations on starting your own business. You can deduct various home office expenses if you meet the requirements. You could deduct a percentage of many of the actual costs of running your home, such as utilities, rent, insurance, depreciation, home insurance, mortgage interest, real estate taxes, and some casualty losses, repairs, and improvements (if they relate to the part of the house you use for business). You could also deduct ordinary and necessary business expenses that you incur at home -- for instance, long-distance phone calls, a separate business telephone line, and the cost of office supplies and equipment. More info from the IRS is available at http://www.irs.gov/newsroom/article/0,,id=108138,00.html and from the SBA at http://www.sba.gov/content/small-business-expenses-and-tax-deductions
 
From:
Veronica Quintana
Location:
Oxnard, CA
 
Question:
What type of documentation should be maintained to substantiate mileage and automobile expenses?
Reply:
Hello Veronica. If you use your car in your business and you use it only for that purpose, you may deduct the entire cost of operation. However, if you use the car for both business and personal use, you may only deduct the cost of the business use. For automobile expenses records such as receipts, canceled checks, and other documents that support the expense would be sufficient. To substantiate the mileage deduction, a mileage log is recommend. The log should show the date, beginning and ending odometer readings of the business trip and the purpose of the trip. Do not include mileage to and from the home office, as it is a non-deductible commuting expense, and for personal trips or errands.
 
From:
Cachet
Location:
Lompoc, CA
 
Question:
I worked full-time this whole year but also made some money as a freelance writer. Since I have employment taxes deducted from my check for my full-time job, do I still have to have them deducted from my freelance earnings? If so, can you specify which form I need to complete to do so because I'm having a difficult time trying to figure it out on my own.
Reply:
Cachet, you must be busy! I'm assuming that you you receive a W-2 from your full time job (reporting on line 7 of Form 1040), and that you are claiming your income and expenses associated with the freelance writing on Schedule C. There are two parts to the payroll taxes that employees and self-employed individuals pay. The portion that is related to social security is typically at 7.65% for employees (but reduced by 2% in 2011 to 5.65%) on all earnings up to the maximum of $106,800 for 2011. Medicare is 1.45%, with no maximum earnings limit. The employer pays payroll taxes of a similar amount. So, for your self-employed earnings, if you have not reached the maximum on SS from the job, you will need to continue to compute and pay SS on your freelance earnings, and you will need to compute and pay the medicare portion as well. See Schedule SE and instructions for details on how to compute your SE tax on the freelance earnings. The tax would typically be remitted as part of any quarterly estimates you need to make to the federal government. You may also want to check out IRS Publication 334 athttp://www.irs.gov/pub/irs-pdf/p334.pdf.
 
From:
Terry Kramer
Location:
Moline, IL
 
Question:
What changes have been made to the Alternative Minimum Tax for 2011 return filing?
Reply:
Terry, There have not been many changes to the AMT for 2011 return filings. The Form 6251 for 2011 is not yet posted on the www.irs.gov forms website. The "patch" enacted by Congress in 2010 sets the 2011 AMT exemption at $47,450 for single filers and $74,450 for married couples, slightly higher than for 2010, so that will be a change in the form. This AMT patch expires at the end of 2011.
 
From:
DOROTHY
Location:
BALTIMORE, MD
 
Question:
Is it better for a husband/wife team to form S-Corp or LLC to pay lower taxes?
Reply:
Neither entity should be picked for that reason. Both entities pass the income and deductions through to the owners on their 1040. S corps are a little bit simpler to maintain, while an LLC which is treated as a partnership can be significantly more complex, and you would need to find a CPA who is qualified in partnership taxation. Therefore, an LLC may be more expensive in terms of compliance fees. S corps are required to pay their owners a reasonable salary for services, while the LLC/partnership generally requires the payment of self-employment tax on most earnings, unless much of it is passive income. So, the choice of entity really depends more on whath type of business operations you will be involved with rather than saving on employment taxes. Overall, without knowing much about your business, I would probably suggest an S corp.
 
From:
Samia Sam
Location:
Long island, New York
 
Question:
Is a self-employed person obligated to depreciate the area of his home allocated to his home office if he operates completely from home. He allocates all other expenses based on the square footage of his home office to his home total square footage. Would the taxpayer be deemed to have taken the depreciation in the case of the sale of his home at a later date as a section 1231 gain and an unrecaptured section 1250 gain?
Reply:
Dear Sam – Generally, if you were entitled to deduct depreciation on the part your home used for business, you cannot exclude the part of the gain equal to any depreciation you deducted (or could have deducted) for periods after May 6, 1997. However, if you can show by adequate records or other evidence that the depreciation you actually deducted (the allowed depreciation) was less than the amount you were entitled to deduct (the allowable depreciation), the amount you cannot exclude (and must subtract from your total gain when figuring your exclusion) is the amount you actually deducted. For additional information, you are going to want to file a Form 4797 and review the instructions. You may also want to review IRS Publication 587 - http://www.irs.gov/pub/irs-pdf/p587.pdf. This is an issue that I would recommend that you discuss with your local CPA. Ed
 
From:
mona tambi
Location:
upper marlboro, md
 
Question:
i currently run my business out of my home. how do i ascertain the percentage of my mortgage which can be deducted. thanks!
Reply:
The principal potion of the mortgage payment wouldn’t be deductible, but the interest would be. Also, a portion of the cost basis of the house (not the land) would be depreciable. To calculate the proper percentage, you’ll need to measure the home office (the square footage) and divide it by the square footage of the entire house. Also remember two things to be able to qualify: (1) you need to regularly and exclusivelly use the office, and (2) it must be the principal place of your business.
 
From:
Linda Fraser
Location:
Rochester, NY
 
Question:
Please clarify C corp and S corp differences
Reply:
All corporations are state-law entities so both entities are subject to state laws regarding corporations. The S corp involves a federal tax election to enable the owners to report the income, deductions, credits, losses, etc on the owners tax return, such as the Form 1040. Except in certain circumstances, there is generally no corporate tax imposed at the S corporation level because all items of income, deductions, etc are reported to the shareholder on a Schedule K-1 and transferred to the 1040, where items are combined with personal items and tax is calcualated on the combined figures. Therefore, S corporation taxable income is subjected to tax at individual rates. C corporation taxable income is computed at graduated corporate rates and than taxed a second time when distributed as dividends. C corporation losses can be carried to other tax years and utilized by the corporation in a year of profit. S corporation losses can sometimes be utilzed against personal income on the individual return.
 
From:
Cachet
Location:
Lompoc, CA
 
Question:
Can you please explain to me how to go about paying estimated quarterly taxes? I've gone on the IRS website to try to figure it out on my own but to no avail.
Reply:
Cachet - To pay estimated quarterly tax payments, you should file the Form 1040-ES and follow the instructions and fill out the worksheet for it at http://www.irs.gov/pub/irs-pdf/f1040es.pdf. You will need to estimate how much taxable income you expect and then figure the tax on that and divide it into four payments that will be due April 18, 2011, June 15, 2011, September 15, 2011, and January 17, 2012. More information is at http://www.irs.gov/businesses/small/article/0,,id=110413,00.html
 
From:
JF
Location:
New York, NY
 
Question:
I am a solo consultant who hired other independent consulting sub-contractors. How do I issue 1099s to them?
Reply:
Generally, you need to provide a Form 1099 to companies in which provide services of $600 or more to you in a calendar year. However, there is an exception for services provided by corporations. You also do not need to file a Form 1099 for the sale of goods – the rules only apply to service providers. Ed
 
From:
Chip Erwin
Location:
Omaha, NE
 
Question:
With the sublet apartment, would I enter the cost of the lease on Schedule E 'Other (List)'?
Reply:
Yes.
 
From:
Carol A. Terry, EA
Location:
Rockford, IL
 
Question:
Participating on behalf of Jennifer Wood, CPA, partner with Sikich LLP, Rockford office. We will be watching developments with international business; questions and planning opportunities. Question: Does anyone have any specific guidelines/checklists to use for Sub S Corporations deciding to remain a Sub S or electing to change to C Corp and timing of same if change is desired.
Reply:
We don't currently have such a product.
 
From:
Katie
Location:
Canaan, NH
 
Question:
I am still in the process of getting my business up and running, yet I've done some billable work. What do I need to know for a sole proprietorship startup?
Reply:
Katie - good luck with your new endeavor. Since you indicate that it is a sole proprietorship, I assume you will be filing a Schedule C with your Form 1040 to report the revenue and expenses associated with the business. There are lots of choices to consider in your first year of operations - including whether to use the cash method or accrual method to recognize revenue and expenses. You may want to check out IRS Publication 334 - http://www.irs.gov/pub/irs-pdf/p334.pdf. It has some basics for small businesses on Schedule C. And IRS publication 538 for more details on tax accounting methods - http://www.irs.gov/pub/irs-pdf/p538.pdf. Make sure you keep good records regarding the costs incurred during the start-up and organization of your business, as there are special rules for the treatment of those expenses. If you are going to use a S-Corp., partnership or C-corp. form, some of the same rules and considerations are necessary, but there may be some differences.
 
From:
Irma Morin
Location:
Nampa, Idaho
 
Question:
We used a Home Equity Line of Credit for our business and we are not able to write off the interest on Schedule C, it can only be written off on our Schedule B although we used the line for our business equipment. Any recommendations?
Reply:
Dear Irma, I am unclear why or how you could write off interest on Schedule B. This is the schedule where you report investment income (interest and dividends). Generally, personal expenses are deducted on Schedule A and business expenses are deducted on Schedule C. I think you have a very fact specific question. You may want to check with your local CPA on this one. Ed
 
From:
Erika
Location:
Connellsville, PA
 
Question:
As a new business owner, whose business will open in 2012, what are some tips to prepare for tax deductions and filing purposes?
Reply:
Erika - Congratulations on your new business that will open in 2012. You may want to look at some IRS information on starting a business at http://www.irs.gov/publications/p535/ch08.html.Tobe deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. Some possible deductible expenses are: employees' pay, retirement plans, rent expense, interest, taxes, and insurance. Good luck with your business.
 
From:
SUSANA ZUNIGO
Location:
IRWINDALE, CA,
 
Question:
For Borrowers that have filed Schedule C 50% - 50% between spouses, once they have expanded their business to two locations, would it be beneficial to establish either an S Corp or LLC?,its a restaurant business, not franchised.
Reply:
The 50/50 arrangement between spouses to report on schedule C was probably not technically proper as it is in reality a partnership subject to Form 1065 reporting rquirements. A Qualified Joint Venture election was enacted a few years ago that was intended to allow spouses to file 2 separate Schedules C, but that election has many problems. Switching to a limited liability entity is probably wise given the potential liabilities associated with operating a restaurant. Whether you choose S Corp or LLC that would depend on a number of factors, including whether you ever expected to admit new owners as you expand. In that case an LLC might be more appropriate; also true if the restaurants own the land they are on. But an S corp is simpler and may serve your purposes very well if you plan to keep it in the family for a long time, for example, or if you want to keep compliance costs down.
 
From:
Cachet
Location:
Lompoc, CA
 
Question:
I saw that someone asked about how to get a federal and state tax ID #. I have a federal one but do also I need to have a state one? If so, why? I currently live in CA and will be here until June. Thank you for your help.
Reply:
Hi Cachet - You may need a state ID as well for payroll purposes. Perhaps state Unemployment tax purposes? You will want to check with California. Ed
 
From:
Britt Travis
Location:
Charleston, Sc
 

What great questions you sent us! Thank you. And thanks to the SBA for providing this service. As I mentioned in my opening, Tax, financial and business planning is a year round venture so we would also encourage you to seek competent advice throughout the year and not just at year end. One resource you might find useful is 360 Degrees of Taxes, a national volunteer effort of the nation’s Certified Public Accountants to help consumers understand their taxes.  http://www.360taxes.org/. Try it out. Thanks again and I wish you a happy holiday season, good health in the new year and success in all of your business ventures.          

            Edward Karl, CPA, AICPA VP Taxation