BUSINESS TOPICS

What does it mean to default on a loan?

A loan default is the failure to meet the financial obligations indicated in the loan agreement that is signed by you and your lender. Often, a loan default translates into the business owner's inability to pay their debts on time. Due to the differences in each loan agreement, default penalties vary. However, the effects of defaulting on the loan fall into two general categories- immediate repercussions and future implications for both you and your business.
 
What are the immediate effects to my business if I default on a loan?

Drop in business and/or personal credit score. Missing your payments and defaulting on your loans negatively impacts your business credit score. Your personal credit score may be affected, depending on the type of business structure that you have in place.  Read on for more tips on how to protect your personal liability.

Increased interest rates. Your business interest rates (and possibly your personal interest rates) may increase if your credit score dips. Depending on your loan agreement, a higher interest rate could affect the loans that you currently have, as well as future loans you plan to seek.

Foreclosure or seizing of property and collateral. Foreclosure may be the most severe repercussion due to a loan default, allowing lenders to recuperate losses from loan defaults. In this situation, your lender will have the full right to take control and ownership of your property and collateral that you have included in your contract. They normally will sell your property privately or by a public auction, depending on the profit margin.

What steps should I take next?

Negotiate terms with your lender. If you default, you can try renegotiating the terms of your loan contract with your lender. While lenders may not always be willing to renegotiate, if you are successful you can minimize the damage to your business's financial health. Ways to reduce the negative impacts of the loan default include:

• Changing the terms of payment e.g. paying less per installment but for a longer period of time
• Paying less over more time with a higher interest
• Asking your lender to forgive a portion of your late payment and agree to pay on time in the future

Consider government debt relief options. There are some government-backed options for managing debt that you can consider, such as the American Recovery and Reinvestment Act (ARRA), ARC Loan Program. and SBA Loan Program. Read more about Managing Small Business Debt through Government Loans and Refinancing Lifelines here.

Cut costs. Minimize your expenses. Though this may not be an ideal situation, you can consider laying off part of your staff and downsizing your business, among others.

Sell business assets. Liquidating business assets or converting your assets into cash may temporarily help you pay off your loans until you can afford to pay your bills on time again.

Consult a lawyer. Consulting a lawyer about your options may also help you through the process. Learn how to find legal representation for your small business here.

What does this mean for the future of my business?

Difficulty finding new loans. After you default on one loan, it will make it much more difficult to find a new loan. If loans are the chief means of financing your business, then you will be running into some difficult hurdles. You may want to start looking into other methods of funding your business. Read more about alternative financing solutions in I Need Money- Where Do I Get It?

Bankruptcy. If your business cannot repay its loans, you may need to file for bankruptcy. Read more about filing for bankruptcy our blog on Bankruptcy Options for Small Business Owners.
 
What Can I Do to Avoid a Loan Default?

Of course, the best way to avoid defaulting is to pinpoint the pitfalls of bad loans and avoid them at all costs. To avoid loan defaults, business owners should remember the following best practices:

• Have a concrete payment plan before you decide to borrow
• Do not offer collateral and property in your contract that you cannot afford to lose
• Read the fine print and thoroughly understand the terms of contract

If you use independent contractors to perform services for your business or rental and you pay them $600 or more for the year, you are required to issue them a Form 1099 at the end of the year to avoid facing the loss of the deduction for their labor and expenses. It is not uncommon to have a repairman out early in the year, pay him less than $600, then use his services again later and have the total for the year exceed the $600 limit. As a result, you overlook getting the information needed to file the 1099s for the year. Therefore, it is good practice to always have individuals who are not incorporated complete and sign the IRS Form W-9 the first time you use their services. Having a properly completed and signed Form W-9 for all independent contractors and service providers eliminates any oversights and protects you against IRS penalties and conflicts.

IRS Form W-9, Request for Taxpayer Identification Number and Certification, is provided by the government as a means for you to obtain the data required to file the 1099s from your vendors. It also provides you with verification that you complied with the law should the vendor provide you with incorrect information. We highly recommend that you have a potential vendor complete the Form W-9 prior to engaging in business with them. The form, available from this site, can either be printed out or filled onscreen and then printed out. The W-9 is for your use only and is not submitted to the IRS.

In order to avoid a penalty, copies of the 1099s need to be sent to the IRS by the last day of February. They must be submitted on magnetic media or on optically scannable forms (OCR forms). This firm prepares 1099s in OCR format for submission to the IRS with the 1098 submittal form. This service provides recipient copies and file copies for your records. Use the worksheet to provide us with the information we need to prepare your 1099s.

Congress considers our tax system as a "pay-as-you-go" system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the "pay-as-you-go" requirement. These include: 

• Payroll withholding for employers; 
• Pension withholding for retirees; and 
• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is 2% higher than the prime rate and the penalty is computed on a quarter-by-quarter basis. 

Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than a de-minimis amount, no penalty is assessed. The de-minimis amount is $1,000. This means, if you owe $1,000 or less on your tax return, you will not be subject to the federal underpayment penalty. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:

1. The first safe harbor is based on the tax you owe in the current year. If your payments equal or exceed 90% of what you owe in the current year, you can escape a penalty. 

2. The second safe harbor is based on the tax you owed in the immediately preceding tax year. If your payments equal or exceed 110% of what you owed in the prior year, you can escape a penalty.

Example: Suppose your tax for the year is $10,000, and your prepayments for the year total $5,800. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception. 

However, in the above example, the safe harbor may still apply. Assume your prior year tax was $5,000. Since you prepaid $5,800, which is greater than the 110% of the prior year's tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.

Note: For 2009, there is a special small business safe harbor for individuals with an AGI for the preceding tax year of less than $500,000 ($250,000 if married filing separately) and at least 50% of the gross income is from a small trade or business.  This special allowance reduces the prior year safe harbor amount to 90%. 

This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc.

With all the recent changes in the tax laws and regulations, the options for deducting the business use of a vehicle are both numerous and generous. In fact, there are so many options that some can easily be overlooked. Note: When a vehicle is used both for personal and business use, the expenses must be prorated based on miles driven for each purpose.

Listed below are some of those options:

• Lease or Purchase – Your first option deals with the manner in which you acquire the vehicle. Whether you decide to lease the vehicle or purchase it, you may choose to deduct the business use of the vehicle using either the actual expense method or the standard cents-per-mile method. Note: If you choose the actual expense method the first year, then the standard cents-per-mile method cannot be used in any future year.
  
• Trade-In or Sell Old Vehicle – If you are replacing an existing vehicle, you have the option either to trade in the old vehicle or to sell it. Without considering other economic factors, if the sale of the old vehicle would result in a gain, then you may wish to consider trading it in and avoid the need of reporting the gain and instead reduce the cost basis of the replacement vehicle. On the other hand, if the sale will result in a loss, then it would probably be better to sell the vehicle and take the loss on your return.
  
• Cents-Per-Mile Method – This method requires the least amount of bookkeeping. You need only record the business miles and total miles driven on the vehicle each year, and the business deduction is the business miles multiplied by the rate for the year. Note: This method cannot be used to compute the deductible expenses of five or more autos owned or leased by a taxpayer and used simultaneously, such as in fleet operations.
  
• Actual Expense Method – As the name implies, this method involves deducting the actual expenses of operating the vehicle. This requires keeping track of the operating costs, including fuel, oil, maintenance, repairs and insurance. In addition, either the annual lease expense or, depending on the class of vehicle, an allowance for wear and tear on the vehicle is added to the annual expenses. A record of the business and total miles must also be maintained to determine the business portion of the expenses.
  
• Class of Vehicle – The class of vehicle affects the limitations that are applied to the allowances for wear and tear available for a particular vehicle.
  
  A. Vehicles With No Limitations: The following vehicles qualify for the Sec 179 deduction, regular depreciation and bonus depreciation. Depending on the methods selected, virtually any amount of the cost of this type of vehicle can be deducted in the year of purchase.
  
  -Heavy Vehicle – A vehicle exceeding 6,000 pounds gross unladen weight such as many of today’s sport-utility vehicles.
  
  -Qualifying Nonpersonal Use Vehicle – A vehicle that has been specially modified with the result that it is not likely to be used more than a de minimis amount for personal purposes.
  
  -Exempt Vehicles – A vehicle used directly in a taxpayer’s trade or business of transporting persons or property for compensation or hire, such as an ambulance, hearse, taxi, clean fuel vehicles, bus or commuter highway vehicles.
  
  B. Those With Limitations: The following vehicles are limited by the luxury auto rules:
  
  -Luxury Vehicle – Generally, a vehicle costing more than an annually inflation-adjusted threshold ($15,300 to $17,004) and not falling into one of the other previous categories. This threshold and the annual limits are not determined until late in the year.
  
  -Special Trucks & Vans – Defined as passenger autos that are built on a truck chassis, including minivans and sport-utility vehicles (SUVs). These vehicles are subject to the annual luxury vehicle limitations, but are allowed an additional $100 added on to those limitations.
  
  C. Vehicles with Other Limitations: In addition to those described above, there are certain other seldom encountered vehicles, such as electric vehicles and certified clean fuel vehicles, with other special allowances.
  
• Interest and Taxes – In addition to the other deductions discussed above, the business portion of personal property taxes, license and interest on the debt to purchase the vehicle are also deductible when the vehicle expenses are being deducted on a business schedule.

It is not coincidental that most conventions are held in resort areas during the spring through early fall months. Convention planners know quite well that convention timing and location is the key to its success. If planned properly, attendees can deduct a portion of the expenses for establishing business relationships and gaining business knowledge while enjoying a mini-vacation. Even without a convention, business travel can be married with some personal relaxation while still providing a partial or complete deduction. It is important to be aware of when the deductions are legitimate as well as when they are not.

Business and Personal Travel 

A taxpayer can deduct all travel expenses while away from home if the primary purpose of the trip was business-related. Expenses such as transportation, meals, lodging and incidentals are deductible provided they are not lavish or extravagant. If the taxpayer engages in both business and personal activities while away traveling, he can deduct the transportation expenses in their entirety if the primary purpose of the trip is business- related. Lodging and 50% of meals is also deductible. Where a companion, such as a spouse, accompanies the taxpayer, the companion's meals and travel expenses are generally not deductible. In addition, deductible-lodging expense is based upon the single occupancy rate.

Cruise Ships

Occasionally, conventions will be held on cruise ships. There are special rules related to the deductibility of cruise ship conventions, and the meeting must be directly related to the active conduct of the taxpayer's trade or business. The cruise ship must be a vessel registered in the United States. All ports of call must be located in the U.S. or any of its possessions. 

In addition, the taxpayer needs to fulfill stringent reporting requirements, including a written statement providing specific information by both the attendee and an officer of the sponsoring organization. Also, the taxpayer is limited to an annual deduction of $2,000 regardless of how many cruises are involved.

Foreign Conventions

In order to deduct a foreign convention (held outside of North America), the costs need to be: 1) directly-related to the active conduct of the taxpayer's trade or business and 2) be just as reasonable to hold the convention or seminar outside the US as it is inside the North American area. 

Please note that a higher standard is applied to foreign conventions than to conventions and seminars held within the North American area. Various factors are considered to determine the reasonableness of the location and convention, including, but not limited to, the meeting's purpose, the sponsor's purpose and activities, the residence of the organization's members, the locations of past and future seminars.

If you have a particular question involving travel and the deductibility of the expenses, please give this office a call so we can assist you.

Self-employed taxpayers should consider their options carefully when it comes to applying tax benefits for their own education tuition and expenses. Tax law provides multiple ways to benefit from the educational expenses and one may provide more benefit to you than another based on your particular set of circumstances. In addition, your tuition may qualify for one tax benefit while other education expenses qualify for another.

• As a Business Expense – Generally, if the education qualifies, it is better to take the cost as a business expense since as a business expense it will offset both income taxes and self-employment tax. The expenses can include tuition, books, supplies, and allowable travel for the education. To qualify as a business expense, the education must either be to maintain or improve your skills or be required in your business. You may, however, not wish to use the education’s costs as a business expense when doing so limits your net profit and consequently limits your pension plan contribution. Another situation when you may not want to claim the education costs as a business expense is when your Schedule C only has a very small profit or shows a loss for the year.

• As an Adjustment to Income – If the education expense is tuition at an institution of higher education and you are under the AGI phase-out limit for this deduction, you have the option to deduct up to $4,000 as an adjustment to overall income for the year. You can take this deduction whether or not the education maintains or improves your skills required in your business. Other expenses related to this education such as books, supplies, and travel can still be deducted on your Schedule C as long as the education maintains or improves your skills required in your business. The deduction is a maximum of $4,000 if AGI does not exceed $65,000 ($130,000 for married couples filing jointly) or a maximum of $2,000 if AGI doesn’t exceed $80,000 ($160,000 for married joint filers). Without Congressional action to extend this deduction, 2009 is the last year it will be available.

• As a Tax Credit – As with the adjustment to income above, if the education expense is tuition at an institution of higher education, you might qualify for the lifetime learning credit. It may be more beneficial than the business expense or AGI adjustment for the tuition portion of the expenses, especially if you are in a lower tax bracket or the business profits are low. The lifetime learning credit allows you a credit of 20% of the cost of your tuition (up to $10,000 of costs) as a tax credit. It, too, has an AGI phase-out limitation. For 2009 and 2010, the credit for single taxpayers phases out between $50,000 and $60,000 and $100,000 to $120,000 for joint filers. Please note that after 2009, this credit may not be allowed if you are taxed by the Alternative Minimum Tax (AMT).

If you have any questions regarding these various options, please call our office.

Another way to reduce the overall family tax bill is by employing family members to work in your business by shifting income to them and providing them with employment benefits.

• Employing your Spouse. Reasonable wages paid to your spouse entitles you to a business deduction. Although the wages are subject to both income and FICA taxes, your spouse may qualify for Social Security benefits to which he or she might not otherwise be entitled. In addition, your spouse may also be entitled to receive coverage under the qualified retirement and health plans of your business, allowing you to obtain business deductions for contributions to your spouse’s retirement nest egg and health insurance premium payments made on behalf of your employed spouse. While maintaining the same family medical care coverage, you increase your business deductions by providing your spouse with family health insurance coverage as an employee.
• Employing your child. By employing your child, the income tax advantages include obtaining a business deduction for a reasonable salary paid to that child, thus reducing your self-employment income and tax by shifting income to the child. Since the salary paid to your child is considered earned income, it is not subject to the “Kiddie Tax” rules that apply to children under the age of 19, as well as some older children. The maximum standard deduction available to your child in 2009 and 2010 is $5,700 if he or she has at least that amount of earned income. Therefore, the standard deduction eliminates all tax on this income if you pay your child $5,700 in compensation. If your business is unincorporated, wages paid to your child under age 18 are not subject to social security taxes. Not only are there significant income tax advantages to employing your child, but you may provide him or her with fringe benefits such as group-term life insurance and qualified pension plan contributions.

Your child may also make deductible contributions to an IRA of the lesser of earned income or the annual limitation. These contributions can offset earned and unearned income. As example, in 2009 and 2010, your child could receive $10,700 gross income ($5,700 earned and $5,000 unearned) by combining the IRA deduction ($5,000) with the standard deduction ($5,700) and pay no tax. You should consider giving him or her part or all of the money needed to fund the IRA (as part of your $13,000/$26,000 annual exclusion gift) if your child does not want to use his or her earned income to fund an IRA contribution.

Please keep in mind that when you employ a family member in your business, the wages should be reasonable for the work performed and that the services performed are necessary to the business.

Becoming self-employed means leaving the comfort of affordable and easily obtainable health insurance. The following tips may save you some of the frustration you may encounter as a self-employed individual in the market for health insurance.

Do your homework. Research the company and policy thoroughly before buying insurance and you may save hundreds of dollars yearly. Here are some guidelines to consider....

• Become familiar with the different policies available. Being ignorant will not help you in your decision-making. You have a wide range of resources such as the Web to determine the pros and cons of each policy.
  
  
• Determine the companies which offer the type of policy that best fits your needs. After you have decided on the type of insurance you need, research the agents and local companies that offer the policies you are looking for.
  
  
• Obtain in writing what the policy will pay for and what it won't. It needs to include the total out-of-pocket expenses you will be liable for and the coinsurance limit. In addition, request a detailed explanation on reimbursement of office visits, prescriptions and emergency room visits. It might also be helpful to find out the hospitals and groups in the coverage area and at which percentage.
  
  
• Before agreeing to a policy that excludes pre-existing conditions, THINK CAREFULLY! Before considering one of these plans, make sure it remains in place for no longer than six months.

Make annual or semi-annual payments of premiums. Ask your agent about service fees and discounts. If you pay annually or semi-annually, the service fee may be waived, and you may receive a discount.

A higher deductible should be taken into consideration. You may want to consider changing to a higher deductible if your family is healthy and has been for a number of years. A higher deductible could significantly reduce your premium. Also read the article "Health Savings Accounts Offer Tax Breaks."

Participate in an independent group plan. To help lower the overall cost of insurance premiums, most self-employed people join associations to enroll in a group health plan. If an existing group health plan is not available, consider starting one within the trade association you are affiliated with.

If the self-employed person considers these issues in the initial process, finding an affordable and convenient health insurance should be effortless. Contact our office for further assistance.

A Health Savings Account (HSA) is a trust account into which tax-deductible contributions can be made by qualified taxpayers who have high deductible medical insurance plans. Income earned on the HSA balance is tax-free. The funds from these accounts are then used to pay “qualified medical expenses” not covered by the medical insurance for an “eligible individual.” If these funds are not used, they roll over year to year. Once the taxpayer turns 65, the funds can be used like a retirement plan (taxable when withdrawn, but not subject to a withdrawal penalty) or saved for future medical expenses. Since the contribution is an above-the-line deduction, a taxpayer need not itemize to take advantage of this tax break. The rules discussed here are applicable to federal tax returns and may not apply to your particular state.

• Eligible Individual – For HSA purposes, the law defines an eligible individual as one who is covered by a “high deductible plan” and, while covered by that plan, is not also covered by another plan that does not have a high deductible. For purposes of determining if a plan does or does not have a high deductible, the law allows certain types of coverage, such as workers’ compensation, insurance for a specific condition, dental care, vision, long-term care and certain others, to be disregarded.
• High Deductible Plans – For 2010, high deductible plans are defined as those with the following deductible amounts:
  
  o Self-only coverage with an annual deductible of $1,200 (up from $1,150 in 2009) or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $5,950 (up from $5,800 in 2009); or
  
  o Family coverage with an annual deductible of $2,400 (up from $2,300 in 2009) or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, of no more than $11,900 (up from $11,600 in 2009).
• Qualified Medical Expenses – Qualified medical expenses that can be paid from these accounts are generally defined as those that would be allowable as a medical deduction on your tax return.
• Contribution Limits – The eligibility and contribution amounts for these accounts are determined monthly. Therefore, during any month in which you qualify, you would be entitled to contribute up to one-twelfth of the annual limits. For 2010, the annual limits (note these values are adjusted annually for inflation) are:
  
  o $3,050 (up from $3,000 in 2009) for single coverage plans;
  o $6,150 (up from $5,950 in 2009) for family coverage plans; and
  o $1,000 (same as 2009) additional for individuals age 55 or older.
  
  Individuals entitled to benefits under Medicare and those claimed as a dependent on another person’s tax return cannot make contributions. Contributions can be made as late as the due date of the tax return without extensions; contributions in excess of the allowable amounts are subject to an annual 6% excise penalty. If your employer makes the contributions for you through a payroll deduction plan, the contributed amounts are not subject to normal payroll withholdings such as FICA and taxes.
  
  Example: John, a single taxpayer, age 58, begins a high deductible health plan with an annual deductible of $5,000 starting in March of 20. We need to determine his maximum annual contribution limit, which is $4,050($3,050 plus $1,000 for being over 55). Next, we divide the annual limit by 12 to determine the monthly limit; in John’s case, it is $337.50 ($4,050/12). Since John was in a high deductible health plan for 10 months during 2010, his maximum contribution limit for 2010 would be $3,375.00 ($337.50 x 10). If John were in the 25% tax bracket, he would realize a tax savings of $844.

Small business owners frequently find it difficult to obtain financing for their businesses without pledging 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 business is deductible against that business. However, depending upon the circumstances of the loan structure, debt secured by the 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 deducted as part of your itemized deductions. Only the excess can be deducted on your business, provided 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 would 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 and 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 a new business. 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 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
Itemized Deduction Alternative Minimum Tax $ 5,238
Business Expense $ 1,587

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, interest on the loan could no longer be deducted as home mortgage interest, since it is a requirement 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 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.

Example: Using the same scenario as the previous example, but electing to treat the mortgage as unsecured by the home, the deductible business interest for the year would be $4,762 [($150,000/$315,000) x $10,000]. None of the balance of the interest would be deductible.

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.

The decision on whether or not to incorporate involves a number of complicated issues. All too often, taxpayers make unwise decisions based on misconceptions of tax benefits available to corporate entities. It is not uncommon at social gatherings to overhear someone talking about incorporating in order to write off this or that. Generally, there is little difference between expenses that are deductible as an individual doing business versus that of a corporation. Although there are some benefits associated with corporations, there are also corresponding negatives. Corporations can take two forms, either a C-corporation or an S-corporation. To gain some insight into the differences between doing business as a corporation or as an individual, let’s review some of the major issues:

Limited Liability – A corporation is an entity unto itself. The shareholder owns an interest in the corporation itself but does not own an interest in the corporation's individual assets. Except in unusual circumstances, a shareholder’s liability is generally limited to his or her investment in the corporation. This is a distinct advantage over an individual doing business, in which both the business and personal assets are at risk.

Double Taxation – Generally, the only way money can be taken out of a corporation is via a reasonable salary, through dividends paid by the corporation, or reasonable interest on stockholder corporate debt. The wages and interest are both deductible to the corporation, but the dividends are not. Thus, there is a potential for double taxation: the stockholder pays individual income tax on the dividends received but the corporation is not allowed to deduct the dividends paid as an expense. If the corporation has a loss for the year, the stockholders (except for S-corporation stockholders) receive no benefit. In contrast, an individual doing business reports on his or her personal tax return the business’ overall gain or loss for the year, and there is never any risk of double taxation. In addition, the individual benefits from a deduction against other income if the business has a loss for the year.

Employee Fringe Benefits – There are a number of fringe benefits available to corporate employees that are not available to or are significantly different for individually-owned businesses. Some of the more popular benefits include pension/profit-sharing plans, group life insurance, group health insurance, disability income coverage, medical reimbursement plans, cafeteria plans and education reimbursement plans. However, shareholders/employees of S corporations do not receive the full range of tax-free fringe benefits that are available to those of a C corporation.

Selling the Business – Generally, selling an individually-owned business involves putting up for sale the various pieces that make up the business such as equipment, real property, goodwill, etc. The business owner is taxed on each piece based on the remaining cost in that item and can sometimes take advantage of the lower capital gains rates. This is also mostly true for S-corporations that sell off the pieces of the business rather than the stock, since they are “pass through” entities. For a corporation, the business can be sold by simply selling the shares of stock to a buyer, resulting in a capital gain (or loss) to the seller. However, in most cases, the buyer prefers an asset purchase, which provides better up-front write-offs and avoids assumption of any prior corporation liabilities. When this happens, the sale of the asset is taxed at the corporation level and will generally be taxed again at the personal level in the form of a dividend, salary, or liquidation.

Administrative Costs - Establishing and maintaining a corporation can be costly. Normally, a lawyer handles the filing of the Articles of Incorporation and states charge for issuing corporate charters. In addition, the corporation must pay yearly fees to maintain its charter and conduct its business. The corporation must maintain a list of all the shareholders and hold at least one shareholder meeting per year, both of which add to its corporate expenses. In contrast, the business operating as an individual does not have these expenses.

Avoid leaping into business structures until you have thoroughly educated yourself and reviewed your options, including exit strategies, retirement plan options, and a whole host of other considerations based on the type of business, business partners, potential liabilities, investment required, estate issues, etc. Please call this office before making your final decision.

As the Internet grows in popularity, your chances of receiving a virus over the Internet increases as your volume of transmission increases. Don't let the fear of acquiring a virus inhibit your use of this fast-growing and valuable technology. Established websites scan constantly for viruses and are usually quite safe. Generally, viruses come from E-mail attachments or harmful websites. Here are tips for limiting your exposure: 

• Never open E-mail attachments whose title ends in .com, .exe or .doc unless you are expecting them.

• Install spyware software to scan websites that can be infected with spyware or adware.
• Disable preview screens when using e-mail.

• When using a real-time virus scanner, download virus updates every week.

• Back up important files often.

• Scan storage media (e.g., USB drives) before using them.

• Avoid those e-mails that have been forwarded from one person to another. They frequently will pick up a virus along the way. If you have a friend that likes to forward e-mails, politely explain the dangers and ask that they not include you.

Retirement plans available to a self-employed individual vary from the very fundamental to the complex variety, which require the services of professional pension plan administrators. Among the plans available are the Keogh, SEP, and Defined Benefit and Simple IRA plans. Because of their complexity and normally high administration costs, the Defined Benefit and Simple IRA plans are not discussed in this article. However, older individuals should take note of the larger retirement contributions available with Defined Benefit plans that could justify the higher administration costs.

Keogh Plans: The overall annual contribution limit to a Keogh plan is 25% of the net profits less the retirement contribution made by the plan itself. After doing the appropriate math, we find 25% of the net profits less the retirement contribution actually equates to 20% of the net profit. The total contribution for the year is also limited to the annual contribution limit.  For 2009 and 2010, that limit is $49,000 and the maximum compensation upon which the contribution is based is limited to $245,000.

Keogh plans must be established before the end of the year for which a contribution is made. However, the contribution for any year can be delayed until later, but not later than the due date of the taxpayer's individual return including extension. Reporting requirements for one participant with Keogh plans require that Form(s) 5500-EZ be filed for the year the assets of all related plans exceed $250,000 and in the final year of the plan.  All other plans must file Form(s) 5500 annually. For calendar year taxpayers, the due date for this report is July 31.

SEP Plans: Unlike the Keogh plan, a SEP plan can be established after the end of the close of the tax year. However, it must be established and funded by the due date of the taxpayer's return plus extensions. SEP plans are also referred to as SEP IRAs since they utilize IRA accounts as the depository for the plan contribution. Even though the funds are being deposited into an IRA account, the SEP contribution has the same contribution limits as the Keogh plan. An additional advantage of a SEP plan is that there are no annual reporting requirements like those that apply to the Keogh plans.

Employees: If a self-employed individual has employees, it may be necessary to include the employees in the plan. Most plans require coverage once an employee attains age 21. With a Keogh plan, you don't have to cover employees until they have completed at least one year of service (two years in some cases). A SEP is a little different, since you only need to cover employees who have worked for you during three of the past five years. Once this test is met, most part-time workers will have to be covered under a SEP.

Successfully passing a family business to the family upon death of the owner is not an easy task. Most business owners fail to realize the importance of a sound business succession plan. As a result, only about half of all family businesses are transferred to the next generation. A significant number are forced to look elsewhere for capital and management expertise.

Without the benefits of a succession plan, grieving loved ones are forced into a business they know little about and can adversely affect the financial stability of the business and the financial security of your family. Not only should management succession be addressed in the business succession plan, but transfer of ownership and estate planning issues as well.

Choosing the successor is one of the biggest challenges in business succession planning. Appraise the individual's strengths and weaknesses and ensure that the individual has the leadership skills and drive to meet the goals of the business. The needs of the business should be your foremost consideration and not the desires of family members. It is imperative that a plan is developed in the early stages so that whomever you choose can benefit from your experience and knowledge.

Other crucial elements of a sound business succession plan is transfer of ownership and estate planning. Buy-sell agreements, stock gifting, trusts and wills are some of the ways to transfer ownership. Each of these means of transfer have specific legal and tax ramifications and should be considered in conjunction with proper estate planning.

Self-employed individuals who pay for lodging expenses while away from home on business can deduct these lodging expenses only if they are substantiated in full (record of time, place, amount, and business purpose, plus paid bills or receipts). The expenses can't be substantiated using the lodging component of the federal per-diem rate.

IRS Office of Chief Counsel points out that Revenue Procedures don't allow self-employed individuals to use the federal lodging per diem rate to substantiate deductions for lodging expenses. For example, a self-employed individual who is away from home overnight on business for three days cannot deduct $150 for lodging (assuming a federal lodging rate of $50 x 3) on the strength of simplified substantiation (written record of time, place, and business purpose). The lodging deduction can only be claimed as a deduction if the expense is documented. Examples of documentary evidence includes receipts, paid bills, or similar evidence.

Unfortunately, if you deduct actual expenses for business use of your car, you probably find your write-offs for depreciation restricted due to so-called luxury car limitations. And most any cars (including trucks or vans) fit the IRS definition of a "luxury vehicle," regardless of their cost. If a vehicle is four-wheeled, used mostly on public roads, and has an unloaded gross weight of no more than 6,000 pounds, the car is considered a "luxury vehicle." 

To see how this works, let's hypothetically say you and an associate each bought a car. Your car costs $50,000 while your associate's costs $32,000. You both use your vehicles 75% for business. Cars are in the 5-year life depreciation category and the first-year depreciation for 5-year life items is 20%.  However, your depreciation deduction for the year (including any choice to expense part of the car's cost) will be subject to the first-year "luxury vehicle" limitation, which is $2,960 for 2009. Rates for current year (2010) are usually not available until later in the year.

Vehicle Depreciation Comparison

1. Vehicle Cost                                                     $50,000  $25,000
2. 20% First-Year Depreciation                          10,000     5,000
3. Luxury Auto Limit                                               2,960       2,960
4. Allowable Deduction (lesser of 2 or 3)          2,960       2,960

As you can see, both you and your associate’s depreciation for the first year is the same amount because of the luxury auto limits.  Thus, your associate will be able to deduct the same amount as you, even though his car had a much lower cost than yours.

In 2009 (and originally in 2008), to stimulate the economy, Congress has temporarily allowed businesses to recover the costs of capital expenditures faster than the ordinary depreciation schedule would allow, by permitting these businesses to immediately write-off 50% of the cost of depreciable property (e.g., equipment, tractors, wind turbines, solar panels, and computers) acquired in 2009 for use in the United States.  This bonus depreciation provision also applies to cars but is limited to a maximum of $8,000.  So, in our example above, the final annual depreciation for 2009 would be equal to $10,960 ($2,960 plus $8,000). Note: This provision will not apply to 2010 unless retroactively reinstated by Congress.

Thus, your first-year depreciation (you used the vehicle 75% for business) will be $8,220 (10,960 x .75)

This may seem unfair, but there is an alternative that can help. Certain sports utility vehicles (a Suburban for example) exceed 6,000 pounds unloaded gross weight and have special rules.

For more information on how to maximize your business vehicle deductions, please give this office a call.

When looking for deductions to add to your taxes, don’t overlook your meal and entertainment expenses. These types of expenses must be “ordinary” and “necessary” to your business or trade and must be “directly related to” or “associated with” the active conduct of business.

In order for the IRS to allow these deductions, good documentation is a requirement and should include the following items:

• The amount
• Date, time and place
• Business purpose
• Names of guests & business relationship

In addition, the surroundings must be conducive for a business meeting, and any discussion before, during or after any meal should be business-related for it to be considered for a deduction. An intimate and quiet location would be appropriate for a business discussion. Refrain from going to places with loud and distracting events that can interfere with the main objective: to talk about business.

A 50% deduction on entertainment expenses is allowed by the IRS if the purpose of the business is to conduct a specific business agenda. The 50% rule also covers the cost of meals during away-from-home business travel. In addition, deductions for expenses related to the meals (e.g., taxes, tips and cover charges) are also limited to 50% of cost; however, this is not true for costs of transportation to and from the meal or entertainment location.

There are other important guidelines to consider so please call our office for assistance.

Business owners – especially those operating small businesses – may be helped by a recent tax law change allowing them to deduct up to $5,000 of the start-up expenses in the first year of the business’ operation. This is in lieu of amortizing the expenses over 180 months (15 years). Note: Start-up expenses incurred prior to October 23, 2004 generally were deducted by amortizing the costs over no less than 60 months. These expenses continue to be eligible for the 60-month amortization.

Generally, start-up expenses include all expenses incurred to investigate the formation or acquisition of a business or to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense also must be one that would be deductible if it were incurred after the business actually began. An example of a start-up expense is the cost of analyzing the potential market for a new product.

As with most tax benefits, there is always a catch. Congress put a cap on the amount of the start-up expenses that can be claimed as a deduction under this special election. Here’s how: If the expenses are $50,000 or less, you can elect to deduct up to $5,000 in the first year, plus you can amortize the balance over 180 months. If the expenses are more than $50,000, then the $5,000 first-year write-off is reduced dollar-for-dollar for every dollar start-up expenses exceed $50,000. For example, if start-up costs were $54,000, the first-year write-off would be limited to $1,000 ($5,000 – ($54,000 - $50,000)).

The election to deduct start-up costs is made by claiming the deduction on the return for the year in which the active trade or business begins, and the return must be filed by the extended due date.

On Schedule C, the deduction is taken as part of the “Other Expenses” in Part V. If the entire amount of start-up costs isn’t deductible in the business’ first year, use Form 4562 to amortize the excess amount over 180 months.

Qualifying Start-Up Costs – A qualifying start-up cost is one that would be deductible if it were paid or incurred to operate an existing active business in the same field as the new business, and the cost is paid or incurred before the day the active trade or business begins. Not includible are taxes, interest or research and experimental costs. Examples of qualified start-up costs include:

• Surveys/analyses of potential markets, labor supply, products, transportation facilities, etc.;
• Wages paid to employees and their instructors while they are being trained;
• Advertisements related to opening the business;
• Fees and salaries paid to consultants or others for professional services; and
• Travel and other related costs to secure prospective customers, distributors, and suppliers.

For the purchase of an active trade or business, only investigative costs incurred while conducting a general search for or preliminary investigation of the business (i.e., costs that help the taxpayer decide whether to purchase a new business and which one to purchase) are qualified start-up costs. Costs incurred attempting to buy a specific business are capital expenses that aren’t treated as start-up costs.

Many of today’s sport utility vehicles that are more than 6,000 pounds in gross weight are not subject to the luxury auto rules. Owners using these vehicles for business historically have been able to utilize both the Sec 179 expense deduction and bonus depreciation, and have not had their depreciation deduction limited by annual caps since the Sec 179 expense limit is in excess of $100,000 and allows taxpayers to write off the entire business portion of an SUV’s cost in the first year.

The Sec 179 expense deduction is limited to $25,000 for sport utility vehicles rated at 14,000 pounds gross vehicle weight or less. The $25,000 represents a substantially higher amount than allowed for other vehicles that are subject to the luxury auto limits.

There are some complicated exclusions to the SUV restriction. They include vehicles that are designed for more than nine individuals, equipped with an open cargo area, etc. Please contact this office for further details.

The recent hurricanes, tsunamis, and terrorist attacks make it clear that even smaller companies are not immune to an unexpected loss. What can you do to prepare and minimize your risk to ensure that such a disaster won’t run you out of business?

Unplanned events can have a devastating effect on your business. You need to be protected from any number of natural and unnatural events such as fire, computer failure, and illness of key staff, all of which can make it difficult or even impossible to continue day-to-day operations.

Good planning can help you take steps to minimize the impact of a disaster and protect your business. The following recommendations can help your business cope with an unforeseen calamity.

Why the Need to Plan?
By identifying possible disasters that may affect you and your business, you may be able to minimize the risks and losses that might occur. A well thought-out business continuity plan will identify an action plan, safety concerns, applicable computer back-ups, and alternative operation headquarters. It will also provide a road map back to normal activities by highlighting the points of contact for insurance and emergency relief way ahead of time.

Educate Your Staff.
How will you escape? Where will you meet up? How will you communicate? Map out and practice escape routes from your building. Familiarize yourself with local authorities and emergency radio signals announced at the time of a disaster. What happens if you survive the disaster but your biggest supplier does not? Develop back-up vendors and relationships ahead of time. Don’t forget that many employees will have families to care for and may have their homes affected by the disaster. Have you stockpiled water, batteries, first aid kits and food in case emergency services are delayed?

Back Up Key Business Information.
Does your computer system have a nightly back-up tape? If the answer is yes, where are the back-up tapes stored? And more importantly, will the back-ups include all of the software needed for your computers to function at another location? Many businesses now have outside vendors that host and back up their computer systems for them. Inquire if they have redundant back-up systems and request information on their emergency plans. If the disaster is only temporary and shuts down the electrical grid to your business, a generator may be a sound investment. The generator can power your computer system, equipment, refrigerators, and other items that might be crucial.

Review Your Insurance Coverage.
As many realize after the fact, they are not insured for many natural disasters under their existing business policy. You may need to add or increase coverage if it is available. Check with your carrier for details on your coverage.

Recovering and Government Assistance
The following government agencies may provide assistance:

• Small Business Administration (SBA) - Provides low interest loans to businesses, homeowners and renters who are victims of a disaster. They even provide loans for the replacement or repair of damaged or destroyed clothing, appliances, furnishings, and automobiles. For more information, visit their website at: www.sba.gov.
  
  
• Federal Emergency Management Agency (FEMA) - Disaster assistance is provided in the form of money or direct assistance to individuals, families and businesses in an area whose property has been damaged or destroyed and whose losses are not covered by insurance. It is meant to help with critical expenses that cannot be covered in other ways. For more information, visit their website at: www.fema.gov.

Since a disaster strikes without warning, being prepared can help your business recover more quickly from a catastrophic emergency. Take the necessary steps to ensure that both you and your business investments are well-protected.

Whenever property is purchased for business use in a business and that property has a useful life of more than one year, its cost must be deducted over its useful life. This accounting procedure is referred to as depreciation. The number of years the property must be depreciated is largely dependent upon the type of property it is. However, there are exceptions to the depreciation requirement:

The tax code contains a special provision that allows certain types of property to be expensed (deducted in year of purchase) rather than being depreciated. This provision is commonly referred to as Section 179 expensing and is limited to a maximum annual amount.  For 2009, the amount is $250,000.  The amount drops to $134,000 in 2010 and will be inflation adjusted in subsequent years.  However, the Section 179 deduction only applies to tangible personal property such as tools, office equipment, machinery, etc. and does not apply to real estate. There are some other restrictions as well, so be sure to contact this office for additional details.

The following are the historical rates for the Sec. 179 expense deduction:

2007 - $125,000(1)(2)
2008 - $250,000(1)(2)(3)
2009 - $250,000(1)(2)(4)
2010 - $134,000 (1)(2)

(1) Married filing separate can only claim ½ the amount shown.        
(2) Enterprise/empowerment zones limit is increased by $35,000.   
(3) One-year increase included in the Recovery Rebates and Economic Stimulus Act of 2008. 
(4) One-year increase included in the American Recovery and Reinvestment Act of 2009.

Caution: The Sec 179 deduction is limited to the taxable income from any active trade or business of the taxpayer(s) including wages. It is also limited if the total cost of property placed into service during the year is over $800,000 in 2009 ($530,000 in 2010).  If married taxpayers file separate tax returns, special rules apply.

Bonus Depreciation - Businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule and the lives listed below.  However, in addition to the increased expensing allowance mentioned above, Congress allows businesses to recover the costs of capital expenditures made in 2009 faster than the ordinary depreciation schedule would allow, by permitting these businesses to immediately write-off 50% of the cost of depreciable property (e.g., equipment, tractors, wind turbines, solar panels, and computers) acquired for use in the United States. This provision does not apply to 2010.

Deducting the Cost of Business Assets - Some assets are depreciated over a specified life. For some assets, the depreciation is straight-line, while for others accelerated methods that front load the deduction may be used. Following are examples of the depreciable life for some commonly encountered business assets. Assets that are used only partially for business must be prorated for business use.

SAMPLE DEPRECIABLE LIVES

Agricultural Equipment 7 Yrs
Automobiles (1) 5 Yrs
Commercial Real Estate 39 Yrs
Land Not Depreciable
Land Improvements 15 Yrs
Office Equipment 5 Yrs
Office Furnishings 7 Yrs
Residential Real Estate 27.5 Yrs
Trucks 5 Yrs

(1) Vehicles under 6,000 lbs. gross unladen weight have additional deduction restrictions.

Business plans are used primarily for raising capital and guiding growth. Not everyone who starts and runs a business begins with a business plan, but it certainly helps to have one.

If you are seeking funding from a venture capitalist, bank, or other lending institution, a comprehensive business plan that demonstrates sound business reasoning will help you negotiate through the funding process. The business plan will convince investors that your new venture is worth funding, that you have identified an opportunity and have gathered the management and organization needed to be successful.

A well-written business plan is the best way to show investors that you deserve their financial support. Make sure that your plan is clear, accurate, focused and realistic. Use it to convince prospective investors that you have the tools, talent and team to build and run a successful business.

A business plan can be a valuable tool in analyzing all aspects of your business as it grows. Since most business owners are in fact learning on the job, a business plan takes this information and analyzes different possibilities without the risk and cost of working them out in real time. A variety of marketing or pricing scenarios can be played out on paper before testing even occurs.

The business plan helps focus the entrepreneur by:

• Defining objectives and detail programs to achieve forecasted results.
• Creating a regular business review and course correction process.
• Evaluating a new product line, promotion, or growth opportunity.
• Analyzing the quality of staff and future staffing needs.
• Clarifying financial requirements and cash flow forecasts.
• Refining strategy when making difficult decisions.
• Determining the strength of the competition and analyzing market trends.

Understanding where your venture is heading can determine whether or not you need to plan. Your business plan can help you work smarter, anticipate the future, test ideas and help create a results-oriented organization.

In general, taxpayers may deduct ordinary and necessary expenses for conducting a trade or business. An ordinary expense is an expense that is common and accepted in the taxpayer’s trade or business. A necessary expense is one that is appropriate for the business. Generally, an activity qualifies as a business if it is carried on with the reasonable expectation of earning a profit.

In order to make this determination the following factors are considered:

• Does the time and effort put into the activity indicate an intention to make a profit?
• Does the taxpayer depend on income from the activity?
• If there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the start-up phase of the business?
• Has the taxpayer changed methods of operation to improve profitability?
• Does the taxpayer or his/her advisors have the knowledge needed to carry on the activity as a successful business?
• Has the taxpayer made a profit in similar activities in the past?
• Does the activity make a profit in some years?
• Can the taxpayer expect to make a profit in the future from the appreciation of assets used in the activity?

The IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five tax years, including the current year — at least two of the last seven years for activities that consist primarily of breeding, showing, training or racing horses.

If an activity is not for profit, losses from that activity may not be used to offset other income. An activity produces a loss when related expenses exceed income. The limit on not-for-profit losses applies to individuals, partnerships, estates, trusts, and S corporations. It does not apply to corporations other than S corporations.

Deductions for hobby activities are claimed as itemized deductions on Schedule A (Form 1040). These deductions must be taken in the following order and only to the extent stated in each of three categories:

• Deductions that a taxpayer may take for personal as well as business activities, such as home mortgage interest and taxes, may be taken in full.
  
  
• Deductions that don’t result in an adjustment to basis, such as advertising, insurance premiums and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
  
  
• Business deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.

Most businesses are made up of different types of assets, and those assets get different treatment for tax purposes. How those items are identified at the time of the sale/purchase can have a significant tax impact on both the buyer and the seller. A seller will, of course, want to designate items into classes that will yield a long-term capital gain on sale and thus provide the best tax result from the sale. Whereas, the buyer will generally want to designate the purchased items into classes that provide the biggest up front write-offs.

The IRS generally does not care how the class allocations are made so long as both the buyer and the seller use consistent treatment. That is where IRS Form 8594 comes in. The form allocates the entire purchase/sale price of the business into the various classes of assets; both the buyer and the seller are required to file the form with their tax returns. It is also very important that allocations be spelled out in the sale/purchase agreement and the treatment be consistent between the buyer and seller.

Generally, assets are divided into the seven categories very briefly described below:

Class I – Cash and Bank Deposits
Class II – Actively Traded Personal Property & Certificates of Deposit
Class III – Debt Instruments
Class IV – Stock in Trade (Inventory)
Class V – Furniture, Fixtures, Vehicles, etc.
Class VI – Intangibles (Including Covenant Not to Compete)
Class VII – Goodwill of a Going Concern

A seller would prefer to designate the major portion of the sales price to goodwill and minimize any allocation to furnishings and equipment. Why, you ask? Because goodwill is a capital asset, which for federal purposes will be taxed at a maximum rate of 15%, while the furnishings and equipment can be taxed as high as 35%. On the other hand, the buyer would prefer to have as much as possible designated as furnishings and equipment, since they can be expensed or written off over a short period of time (usually 5 or 7 years) as opposed to a 15-year amortized write-off of the goodwill.

Whether you are the buyer or the seller, don’t leave the asset allocations to chance. Negotiate the allocation as part of the sales agreement. If you don’t, you could easily end up with inconsistent treatment and potential adjustments by the IRS.

If you are anticipating a sale, please call this office so we may assist you in structuring the transaction to your best benefit.

When prospecting for new customers, it is usually very positive to note that most businesses already have one or more "big-name" customers in their stable. The prospect will likely believe that the large company chose them based on their superior products or services, and assume that they are a credible supplier. It just may cinch the deal, right?

Besides credibility, large clients bring prestige and significant revenues to a business. And the scale of serving a large customer may lower product costs or allow the owner to purchase production equipment. For example, a manufacturer's unit costs typically decline with larger throughputs. The scale of business may also justify the addition of skilled personnel, office equipment and technology – making a business more attractive to other prospective customers.

However, from an overall business standpoint, what are the risks of a single customer comprising a high percentage of the revenues? Consider these possible downsides:

• Stretched resources - If too many resources are dedicated to the large customer, smaller clients will feel ignored and begin to depart.
  
  
• Lack of profits - Analyze margins on the large clients. Sometimes we give away our margins in favor of big volumes.
  
  
• Debt - Do not go overboard meeting the demands of the client by going into excessive debt. If they drop you as a vendor, the debt remains.

Of course, many small businesses can't help but have a handful of customers who generate a large percentage of the company's revenues. There's nothing inherently wrong in that. However, don’t let the 80/20 rule of thumb make you a slave to one or two large customers.

The 80/20 rule maintains that 80% of a company's business comes from 20% of its customers. And a common strategy asserts that a company should coddle its "best" customers, at the expense of its smallest.

Like many "rules of thumb," it's not that simple. Small- and medium-sized customers are important, too. Here's why:

• Smaller customers often deliver better gross margins. They have fewer choices and don't have the negotiating power of large customers.
  
  
• A relatively large number of smaller customers bring stability to a business. Treat them well and they will stay and spread the word to others. Loyalty is important to them, and they won't change vendors if they are content. Furthermore, smaller companies are targeted less frequently by competitors – they are too busy chasing the big fish.
  
  
• A sizable base of smaller customers makes a business owner less susceptible to the loss of a big-name customer. And lenders shy away from companies that appear to be too dependent on a few customers.

If more than 30% of sales are being done with any customer, it may spell trouble. From a risk viewpoint, it's best to have no customers accounting for more then 10% of revenues.

It takes careful planning to keep a business successful. What many family business owners fail to realize is that a succession plan is a necessity, not an option. There are many ways to hand down the business to the next generation, but your main objective is to minimize the impact of estate taxes on your heirs. This will help them avoid having to dispose of the business.

One way to hand down the business is by transferring stock from the family business owner to the younger family members. Since stock transfers can take many forms and can be used either individually or in combination, a few methods are discussed below. Keep in mind that these methods assume that the family business has been legally incorporated.

1. Gifting stocks tax-free: By gifting some or all of the stock to the next generation during the owner’s lifetime, the owner is not subject to income tax on the gift. However, the younger family members may be subject to a larger tax penalty if and when the stock is sold. Since the gifted stock is acquired at the owner’s original cost and not at market value at the time of the gift, the significant difference (which is often the case) is fully taxable. In addition, gift tax may be applicable if the stock value gifted by the owner exceeds the $13,000 (inflation adjusted amount for 2009 and 2010) gift tax exclusion allowed for each recipient.


2. Bequeathing stock: This is considered as an economical method from an income tax standpoint and can be done by the controlling owner’s will. Since the younger family members obtain the stock at its fair market value, any potentially substantial gain is not subject to income tax. However, bequeathed stock is included in the decedent’s taxable estate and subject to estate tax at rates that can go as high as 45 percent (2009 percentage rate - however, legislation is expected to change the rate for 2010).


3. Selling the stock: Another option of the controlling owner is to sell his or her stock to the younger generation. The buyer may purchase the stock in exchange for cash or a note payable over time, but it must be paid for with after-tax dollars. It is most likely that the seller will recognize taxable gain on the sale, but if the sale is for a note, the gain can be deferred until the cash is received. Gift tax may also apply to the extent that the selling price is less than the fair market value of the stock.


4. Private annuity: If you are considering selling stocks, a private annuity may be a better alternative than setting a fixed price. With a private annuity, the seller receives a fixed amount on a yearly basis for life.


5. Buy/sell agreement: Another method that is used to transfer stock is through a buy/sell agreement. This is a legal document that specifies how stocks in the business are to be transferred in the future. Having this type of agreement ensures that the business transfer is carried out according to the agreed plan.


6. Redemption: This applies if the younger generation already owns stock in the family business. If that is the case, the corporation can redeem the controlling owner’s stock. The owner is faced with similar tax consequences to that of a sale. The only difference with a redemption is that it eliminates the need for the next generation to come up with after-tax cash.

Before deciding on a course of action, please consult your tax advisor. Tax issues are complicated and professional advice is strongly suggested.

Tax laws provide for plans that allow self-employed individuals to establish retirement plans for themselves and their employees, if they have any. Those most frequently encountered are the SEP (Simplified Employee Pension) and Keogh Profit Sharing Plans. Even though they are not IRAs, the SEP plans utilize an IRA account as the depository for the SEP plan contribution, thus minimizing the administration requirements of the employer.

The compensation limits for both of these plans is generally 25% of compensation. The following details the differences between contributions for employees and the amount allowed for the self-employed individual.

• Employees: Contributions in 2009 and 2010 on behalf of an employee are generally limited to the lesser of $49,000 or 25% of the employee’s compensation (up to the compensation limit). The compensation limit for 2009 and 2010 is $245,000.

• Self-Employed Individual: The contribution limit is 25% of the net profits from self-employment (20% of the net profits before deducting the contribution itself). The contribution is also limited to the same maximum contribution amount and compensation limits as the employee.

If you are considering establishing a qualified pension plan for your business, you may be entitled to the “small employer pension start-up credit.” Eligible small employers that adopt a new plan, such as a 401(k), SIMPLE plan, or simplified employee pension plan (SEP), may claim a nonrefundable credit. The credit is equal to 50% of administrative and retirement-related education expenses for the plan for each of the first three plan years, with a maximum credit of $500 for each year.

The first credit year is the tax year that includes the date the plan becomes effective, or, electively, the preceding tax year. Examples of qualifying expenses include the costs relating to changing the employer’s payroll system, consulting fees, and set-up fees for investment vehicles.

There are some qualification rules; the most predominate being:

o The business did not employ, in the preceding year, more than 100 employees with compensation of at least $5,000.

o The plan must cover at least one non-highly compensated employee.

o The plan must be a new one – during the three prior years, the employer may not have had a qualified employer plan for which contributions were made or benefits accrued for substantially the same employees who are in the plan for which the credit is being claimed.

o If the credit is for the cost of a payroll-deduction IRA plan, the plan must be made available to all employees who have worked with the employer for at least three months.

No deduction is allowed for that portion of the qualified start-up costs paid or incurred for the tax year which is equal to the credit. However, an eligible employer may elect not to have the credit apply for any tax year.

Included in the Small Business and Work Opportunity Act of 2007 is a provision that allows a husband and wife who file a joint return to elect out of the partnership rules. Thus, a joint venture between them is not treated as a partnership for tax purposes. This new rule takes effect for 2007.

All items of income, gain, loss, deduction, and credit are divided between the spouses according to their respective interests in the venture, and each spouse takes into account his or her respective share of these items as if they were attributable to a trade or business conducted by the spouse as a sole proprietor. Thus, each electing spouse will report his or her shares on the appropriate form, such as Schedule C.

A qualified joint venture means any joint venture involving the conduct of a trade or business if:

(1) The only members of the joint venture are a husband and wife,
(2) Both spouses materially participate (1) in the trade or business, and
(3) Both spouses elect the application of this rule.

(1) The definition of material participation provides for whereby a taxpayer can qualify. However, generally, to qualify, 500 hours of participation are required during the year, or if participation is less than 500 hours, the taxpayers must provide substantially all of the participation.

Notwithstanding other self-employment rules, each spouse's share of income or loss from a qualified joint venture is taken into account under the above rules in determining the spouse's net earnings from self-employment.

Similarly, each spouse's share of income or loss from a qualified joint venture is taken into account under the above rules in determining the spouse's net earnings from self-employment for purposes of the Social Security benefit rules. Thus, each spouse will receive credit for his or her self-employment tax contributions for purposes of receiving Social Security benefits. However, this rule is not intended to prevent allocations or reallocations, to the extent permitted under pre-2007 Small Business Act law, by courts or by the Social Security Administration of net earnings from self-employment for purposes of determining Social Security benefits of an individual.

If you would like to discuss how this new legislation might fit your current or planned business model, please give us a call.

If you are a small business owner, whether you hire people as independent contractors or as employees will impact the amount of taxes you withhold from their paychecks, as well as how much and what types of taxes you pay.  Furthermore, it will affect how much additional cost your business must bear, what documents and information must be provided to you, and what tax documents must be given to the individuals you are hiring.

The obvious advantage to treating an individual as an independent contractor is avoiding the added expense of payroll taxes and employee benefits.  Unfortunately, the decision is not an optional one and employers must be careful when making the decision, lest they set themselves up for a payroll audit and back taxes, penalties and interest.

According to industry sources, the IRS will begin auditing companies in early 2010, focusing their efforts on businesses failing to pay taxes on fringe benefits and misclassifying workers as independent contractors instead of W-2 employees.

Here are some things every business owner should know about hiring people as independent contractors versus hiring them as employees.

1. Three characteristics are used by the IRS to determine the relationship between businesses and workers: Behavioral Control, Financial Control, and the Type of Relationship.

2. Behavioral Control covers facts that show whether the business has a right to direct or control how the work is done through instructions, training or other means.

3. Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job.

4. The Type of Relationship factor relates to how the workers and the business owner perceive their relationship.

5. If you have the right to control or direct not only what is to be done, but also how it is to be done, then your workers are most likely employees.

6. If you can direct or control only the result of the work done, and not the means and methods of accomplishing the result, then your workers are probably independent contractors.

7. Employers who misclassify workers as independent contractors can end up with substantial tax bills.  Additionally, they can face penalties for failing to pay employment taxes and not filing required tax forms.

8. Workers can avoid higher tax bills and lost benefits if they know their proper status.

9. Employers can request the IRS to make a determination on whether a specific individual is an independent contractor or an employee by filing a Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) with the IRS. A worker may also file Form SS-8 requesting an IRS determination. IRS does not issue determinations for proposed or hypothetical situations.

The 20-Factor Control Test - Congress views the independent contractor as a source of tax gap funding and may, in the near future, alter the definition of an independent contractor and impose mandatory withholding.  However, currently, a worker’s status as an employee or independent depends on the amount of control the employer has over the worker. The IRS has developed 20 factors to help determine the extent of this control. The importance of each factor varies depending on the kind of work being done. Lack of control isn’t necessarily shown if an employer allows a worker freedom of action. The 20 factors are:

(1) Instructions: A worker who must comply with instructions about when, where and how to work is considered an employee. An employer has control in this area if he/she has the right to require compliance with instructions.

(2) Training: Independent contractors ordinarily use their own methods and receive no training from their customers about how to do the job. On the other hand, training given the worker by the employer usually shows employee status.

(3) Integration: Employee status is often shown when a worker’s services are integrated into the business’ operations and the success of the business depends on the performance of those services. This factor may be one that works against supporting independent contractor status in nearly every situation--it’s very difficult to establish whether or not success of a business would depend on the worker’s contribution to an overall effort.

(4) Services rendered personally: A business which requires the worker to personally perform the services shows that the business is interested in the methods used to accomplish the tasks. This, then, shows control by the employer.

(5) Hiring assistants: If a worker hires, pays and supervises assistants to complete a contract that requires the worker to supply materials and labor and be responsible for the result, then the worker is independent. When the employer hires, supervises and pays assistants to help the worker, employee status is indicated for the worker.

(6) Continuing relationship: An employer-employee relationship is indicated if there is an on-going relationship between the employer and worker. This kind of relationship often exists where work is performed at frequently recurring (although irregular) intervals.

(7) Set hours of work: While employees normally have set hours of work, independents set their own hours.

(8) Full-time work: Independents work when and for whom they choose, while employees must work full-time for a business, with restrictions on the worker being able to work elsewhere.

(9) Work done on the premises: Work required to be done on the employer’s premises often indicates control, especially if the work could be done elsewhere. However, control may even be present when a worker performs services in his/her own offices. To pinpoint the importance of this factor, look at the nature of the services being performed. Control over the place of work may be indicated when the business has the right to compel the worker to travel a certain route or work at specific places. The worker should be required to work from his/her own office.

(10) Order of sequence set: When the employer sets the order of an employee’s duties, it shows control by the employer.

(11) Reports: If a worker must submit reports (oral or written) to the employer to account for his/her actions, control is also shown.

(12) Payments: Employee status is shown if a worker is paid by the hour, week, etc. The worker should not be guaranteed a minimum salary nor be offered any fringe benefits. If a drawing account is set up for the worker, the worker should be required to repay any excess drawn from the account over commissions earned. In effect, the job should be paid on a straight-commission basis.

(13) Payments of expenses: If the employer pays business or travel expenses of the worker, the worker is likely to be classed as an employee.

(14) Tools and materials: An employer furnishing all the tools and materials to do the job usually shows that an employer-employee relationship is operative.

(15) Significant investment: An independent has significant investment in facilities or equipment used to perform services for someone else.

(16) Profit or loss: An independent contractor can realize a profit or loss as a result of services performed. For example, a worker who has invested in expensive equipment to do a job runs the risk of incurring a heavy loss from the job. This indicates that the worker is an independent contractor. However, the risk that a worker will not be paid is not sufficient risk to categorically show independent status.

(17) Working for more than one business at a time: When a worker performs services for multiple firms at the same time, independent status is indicated.

(18) Offers service to the general public: When a worker who regularly and consistently makes his/her services available to the general public, he/she is an independent contractor.

(19) Right to fire: Whereas an independent can’t be fired as long as he/she produces a result that meets the specifications of the contract, an employee can be fired.

(20) Right to quit: The reverse of (19) is true here: an employee can quit a job at any time without incurring liability. However, an independent is responsible to meet the terms of a contract.

It is wiser to properly classify workers to begin with rather than find out later they have been misclassified and find yourself facing back payroll taxes and penalties. Please call this office if you have questions or need assistance in classifying your workers.

In a world where 30% of applicants give false or misleading information about their backgrounds, adding employee background checks to the hiring process is the employer’s first line of defense in hiring good people, and possibly avoiding negligent hiring lawsuits.

Background checks supplement the interviewing process, confirm information provided by applicants, and uncover inaccurate information. Background checks do not rely on getting references from former employers who may be fearful of being sued.

Though the information from background checks varies, this information can identify some of the following problems:

• A given residential address that is commercial, including a bar, mail forwarding service, or homeless shelter
• A residential address that may have been used in suspected fraudulent activity
• Failure to appear for court appearance
• Differences between the legal name and the name on the application
• Variations in the legal name
• Criminal records located under an alias
• Applicant with multiple aliases, an incorrect Social Security number, or multiple numbers
• Use of Social Security number in a death benefit claim
• Use of Social Security number in fraud-related (credit card) activities
• Convictions:
  a. Assault/battery
  b. Forgery
  c. Theft
  d. Probation violation
  e. Possession of firearms/carrying concealed firearms
  f. Possession of a controlled substance
  g. Under the influence of a controlled substance
  h. Operating a motor vehicle on a suspended license
  i. Infliction of injury on spouse or child
  j. Burglary
  k. Credit card fraud
  l. Driving under the influence (multiple offender)
  m. Disorderly conduct
  n. Resisting arrest
  o. Indecent exposure
  p. Tampering with government records
  q. Grand theft auto

Background checks serve as an insurance policy and may identify potential issues that may not have been uncovered during the hiring process. If you are running a high-risk or turnover business, it might make sense to add background checks to your hiring procedures.

In a recent tax court case, an employer (and not the employer’s payroll service provider) was ultimately held responsible for the payment of income tax withholding and the employee and employer portions of the Social Security and Medicare taxes.

Businesses frequently outsource their payroll and other related responsibilities to companies who specialize in these services. However, it is the employer's duty to pay these taxes, and ultimately the employer remains responsible for their payment even if the failure to pay is entirely due to a payroll service provider's negligence or fraud.

Don’t allow yourself to become complacent just because your company uses a highly-respected payroll service. Because of the issues surrounding the court case, the IRS and the Social Security Administration offer the following advice to employers:

• They strongly suggest that the address of record with IRS not be changed to that of the payroll service provider. If there are any issues with an account, the IRS will contact the employer. Changing the address may significantly limit the employer's ability to be informed of tax matters involving his or her business in a timely manner.
  
  
• An employer should ask the payroll service provider if they have a fiduciary bond. This can protect the employer in the event of default.
  
  
• The employer should ask the service provider to enroll in and use the Electronic Federal Tax Payment System (EFTPS). The EFTPS maintains the payment history of a business for 16 months and can be viewed online. This allows the employer to immediately confirm payments electronically, 24 hours a day, 7 days a week through the Internet or by phone. The IRS recommends employers verify EFTPS payments as part of their bank account reconciliation process.

The IRS further cautions that there have been instances of individuals and companies acting under the guise of service providers who have stolen funds intended for payment of employment taxes, leaving the employer ultimately responsible for the payroll taxes and penalties.

Under IRS regulations, employment tax records must be maintained for at least four years after the later of the due date of the tax for the return period to which the records relate, or the date the tax is paid. The records should include the following information:

• Employer identification number (EIN);
• Amounts and dates of all wage, annuity and pension payments;
• Amounts of tips reported;
• The fair market value of in-kind wages paid;
• Names, addresses, Social Security numbers and occupations of employees and recipients;
• Employee copies of Form W-2s that were returned as undeliverable;
• Dates of employment;
• Periods for which employees and recipients were paid while absent due to sickness or injury, and the amount and weekly rate of payments made to them by the employer or third-party payers;
• Copies of employees' and recipients' income tax withholding allowance certificates (Forms W-4, W-4P, W-4S and W-4V);
• Dates and amounts of tax deposits;
• Copies of returns filed;
• Documentation for allocated tips; and
• Documentation for fringe benefits provided, including substantiation.

A willful failure to keep required records is a misdemeanor punishable by a fine of up to $25,000 ($100,000 for corporations) and/or imprisonment for up to one year.

If you need assistance organizing your records and have further questions related to your recordkeeping requirements, please give us a call.

If you, as an employer, provide incentives as a way to award top-performing employees for extraordinary accomplishments, you need to keep in mind that they are considered taxable fringe benefits. Thus, awards such as merchandise or a vacation trip are non-cash fringe benefits that are taxable to the employee and deductible by you, the employer, as compensation. The fair market value of the award should be shown as wages on the employee's W-2.

Since these awards are a type of supplemental wages, employers must, under the general rules, withhold income, social security, and Medicare taxes and deposit the withheld taxes along with employer matching amounts in the same deposit period they were treated as paid. Note: If you, as the employer, pay the withholding taxes on the incentive award for the employee, then those amounts are also considered compensation.

Under the optional flat-rate procedure, for federal purposes, employers withhold on supplemental wages at the third lowest tax rate for single filers, which is currently 25%. However, if a supplemental wage payment when added to all other supplemental wage payments previously made by the employer to the employee during the calendar year exceeds $1 million, the excess is subject to mandatory withholding at the highest income tax rate in effect for that year. The highest rate is currently 35%. Withholding of state income taxes generally will also be required.

Employers may treat taxable non-cash fringe benefits as paid by the pay period, by the quarter, or on any other basis as long as they are treated as paid at least once a year. However, this rule does not apply to:

(1) The transfer of tangible or intangible personal property of a kind normally held for investment; or

(2) The transfer of real property.

In these situations, the actual property transfer date is used in determining when the benefit was “paid.”

Non-Cash De Minimis Fringes - The incentive award rules don't apply to non-cash employee achievement awards of tangible personal property made for length of service or safety. Such awards are deductible by the employer, and excludible by the employee, within certain limits. Additionally, non-cash de minimis fringes, such as traditional birthday or holiday gifts of property with a low fair market value, or occasionally gifts of theater or sporting event tickets, are deductible by the employer and tax-free to the employee.

If you have any questions about employee incentive awards or non-cash de minimis fringes, please call our office.

The two primary ways of taking money out of a corporation is as compensation for work or as a dividend; each has different tax consequences. Salaries and bonuses are deductible by the corporation and taxable to the recipient employee, whereas dividends are not tax-deductible by the corporation and are taxable to the stockholder recipient. Thus, the dividends are taxed twice.

If you think you can avoid double taxation by only taking compensation and never paying dividends--think again! To counter that strategy, tax law includes a provision that says that compensation can be deducted only to the extent that it is reasonable. This is most frequently encountered where the employee is a shareholder or is related to a shareholder.

There is no magic formula for determining reasonable compensation. It is generally based on fact and circumstances and what is comparable for other companies in the same business. Factors that are considered when making that determination include:

• Company employee salary policy;
• Time spent to perform job duties;
• Employee's duties and responsibilities;
• Employee's abilities and accomplishments;
• Business’s complexities;
• Income of the company, both gross and net;
• Historical compensation history;

To reduce the chances of having compensation deemed as “unreasonable” by the IRS, there are some steps you can take. For example:

• Document in the corporate minutes the reasons for the level of salary or why bonuses are being paid.
  
  
• If the current year’s salary has been increased to make up for a salary that was too low in prior years, document that in the corporate minutes. Hopefully, you included notations in the prior years’ minutes stating that the compensation was at a reduced rate.
  
  
• Don’t pay salaries in direct proportion to the stock ownership. It looks too much like a disguised dividend.
  
  
• Keep your salary in line with others in the same industry. Document your research in case you are later called upon to prove it.
  
  
• Pay out at least some dividends if the business is profitable, thus avoiding the impression that the corporation is trying to pay out all of its profits as compensation.

The issue of reasonable compensation usually occurs a couple of years after the payments are made and can have effects on multiple years. Therefore, it is best to plan ahead and avoid problems later. Please give us a call if we help with this issue.

Employers can qualify for a tax credit known as the work opportunity tax credit (WOTC) that is worth as much as $2,400 for each eligible employee (higher amounts for certain veterans and others special categories). The credit is available on an elective basis for employers hiring individuals from one or more of twelve targeted groups. The amount of the credit available to an employer is determined by the amount of qualified wages paid by the employer. Generally, qualified wages consist of wages attributable to service rendered by a member of a targeted group during the one-year period beginning with the day the individual begins work for the employer. The WOTC will offset the Alternative Minimum Tax (AMT).   Note: To qualify for this credit, a qualifying individual must begin work before September 1, 2011.

Members of Targeted Groups

A job applicant may be certified as a member of a targeted group if he or she is described in one of the following groups.

1.  “Unemployed veteran" - is any veteran who is certified by the designated local agency (such as a state workforce agency) as having been discharged or released from active duty in the Armed Forces at any time during the five-year period ending on the hiring date, and as being in receipt of unemployment compensation under state or federal law for not less than four weeks during the one-year period ending on the hiring date. A "veteran" is any individual who is certified by the designated local agency as having served on active duty (other than active duty for training) in the Armed Forces of the United States for a period of more than 180 days or as having been discharged or released from active duty in the Armed Forces for a service-connected disability. Hire date must be after 2008 and before 2011.

2.  “Disconnected youth" – is any individual who is certified by the designated local agency as being between the ages of 16 and 25 on the hiring date; as not having been regularly employed or regularly attended any secondary, technical, or post-secondary school during the six-month period preceding the hiring date; and as not readily employable by reason of lacking a sufficient number of basic skills. An individual is considered not regularly employed if, during each consecutive three-month period within the six months preceding the hiring date, the individual earned less than an amount equal to the gross amount the individual would have earned working at the minimum wage for 30 hours every week during the three-month period. The individual may not have a certificate of graduation from a secondary school or a General Education Development (GED) certificate, or if the individual does have a certificate, it must have been award at least six months prior and he or she may not have held a job (other than occasionally) or been admitted to a technical or post-secondary school since receiving the certificate.   Hire date must be in 2009 or 2010.

3. Qualified IV-A recipient – is an individual who is a member of a family receiving assistance under a state plan approved under part A of title IV of the Social Security Act relating to Temporary Assistance for Needy Families (TANF). The assistance must be received for any 9 months during the 18-month period that ends on the hiring date.

4. Qualified veteran - A veteran who is any of the following.

• A member of a family receiving assistance under the Food Stamp program for at least a 3-month period during the 15-month period ending on the hiring date.

• Entitled to compensation for a service-connected disability and is hired not more than 1 year after being discharged or released from active duty in the U.S. Armed Forces.

• Entitled to compensation for a service-connected disability and was unemployed for a period or periods totaling at least 6 months (whether or not consecutive) in the 1-year period ending on the hiring date.

To be considered a veteran, the applicant must:

• Have served on active duty (not including training) in the Armed Forces of the United States for more than 180 days (not including training) or have been discharged or released from active duty for a service-connected disability, and

• Not have a period of active duty (not including training) of more than 90 days that ended during the 60-day period ending on the hiring date.

5. Qualified ex-felon - An individual who has been convicted of a felony under any federal or state law, and is hired not more than 1 year after the conviction or release from prison for that felony.

6. Designated community resident - An individual who is at least age 18 but not yet age 40 on the hiring date and lives within an empowerment zone, renewal community, or rural renewal county.

7. Vocational rehabilitation referral. An individual who has a physical or mental disability resulting in a substantial handicap to employment and who was referred to the employer upon completion of (or while receiving) rehabilitation services by a rehabilitation agency approved by the state, an employment network under the Ticket to Work program, or the Department of Veterans Affairs.

8. Summer youth employee. An individual who:

• Performs services for the employer between May 1 and September 15,

• Is age 16 but not yet age 18 on the hiring date (or if later, on May 1),

• Has never worked for the employer before, and

• Lives within an empowerment zone, enterprise community or renewal community.

9. Food stamp (also termed the Supplemental Nutrition Assistance Program, or SNAP) recipient. An individual who:

• Is at least age 18 but not yet age 40 on the hiring date, and

• Is a member of a family that—

a. Has received food stamps for the 6-month period ending on the hiring date or

b. Is no longer eligible for such assistance under section 6(o) of the Food Stamp Act of 1977, but the family received food stamps for at least 3 months of the 5-month period ending on the hiring date.

10. SSI recipient - An individual who is receiving supplemental security income benefits under title XVI of the Social Security Act for any month ending during the 60-day period ending on the hiring date.

11. Long-term family assistance recipient - An individual who is a member of a family that:

• Has received temporary assistance for needy families (TANF) payments for at least 18 consecutive months ending on the hiring date, or

• Receives TANF payments for any 18 months (whether or not consecutive) beginning after August 5, 1997, and the earliest 18-month period beginning after August 5, 1997, ended during the past 2 years, or

• Stopped being eligible for TANF payments because federal or state law limits the maximum period such assistance is payable and the individual is hired not more than 2 years after such eligibility ended.

12. Hurricane Katrina employee - A Hurricane Katrina employee is a person who, on August 28, 2005, had a main home in the Gulf Opportunity (GO) Zone (core disaster area) and, during a two-year period beginning on this date, is hired to perform services principally in the GO Zone. Certification does not apply to this group.

If you think you qualify for this credit or would like to discuss how taking advantage of it might benefit your business, please give us a call.

The domestic production deduction was created to encourage manufacturing and production within the U.S., and at times is confusing, but it provides a beneficial business deduction equal to 6% of the lesser of net income from qualified production activities or 50% of the W-2 wages paid to employees properly allocated to the domestic production activity.

For 2010 and later years, the deduction percentage is 9% (up from 6% in 2009). Thus, it represents a sizeable business deduction that can have a substantial impact on your tax bottom line.

In recent guidance, the IRS reversed earlier positions, now allowing:

- Gross receipts from providing software for a customers' direct use while connected to the Internet to be treated as derived from a qualifying disposition.

- Gross receipts derived from materials and supplies consumed in a construction project to be included in domestic production gross receipts from the construction of real property.

Generally, the deduction is allowed to all taxpayers, including individuals, corporations, farm cooperatives, estates and trusts. The deduction is passed through to owners of partnerships, S-corporations and cooperatives, allowing them to deduct it on their own returns.

The following is an example of how this deduction works. Suppose your business manufactures a product that you wholesale to retailers. Your net income from sales of that product for the year is $800,000, and the wages you paid your employees to manufacture that product totaled $100,000. Your deduction for 2010 would be the lesser of 9% of the $800,000 in revenue or 50% of the $100,000 wages. Thus, your business domestic production activities deduction would be $50,000 (50% of $100,000).

The IRS guidance also provides simplified methods of determining the deduction. If you need assistance in setting up your accounting to accommodate this deduction, please give this office a call.

Most small businesses have receivables that cannot be collected. These receivables can be from the sale of products, providing services to customers, or a combination of the two.

Whether or not a bad debt deduction will apply generally depends upon which accounting method is used (either the cash or accrual method). Why does this make a difference? Let’s look at what happens under both methods of accounting.

• Accrual – If the accrual method is used, all of your billings must be treated as income whether or not they have been collected. This means that the taxable income already includes the income from your deadbeat customers. Therefore, these items are considered a bad debt when those receivables become uncollectible and can be deducted. If the accrual method of accounting is used, bad debts are deductible.
  
  
• Cash – On the other hand, if the cash method of accounting is used, income is not reported until it is received (unlike the accrual method). Since the income was never reported in the first place, a deduction cannot be taken if you are never paid for the goods or services you provided. This is a hard concept to understand, so let’s consider the following example. Jack has a cash basis business with two customers. He invoices both customers for $5,000. One pays Jack promptly, while the other skips out on him without making payment. Jack actually has income of $5,000. If he were allowed to deduct the uncollected $5,000, he would end up with $0 income. However, this is not the case. Generally, cash basis businesses don’t have bad debt deductions, although there are some exceptions (discussed below).

A taxpayer's loan to a customer or supplier may be a business debt if there is some element of necessity for the loan, which is proximately related to the taxpayer's business. An example is a builder who makes advances to a building material supplier and never receives the supplies. In such cases, assuming the taxpayer can prove the debt is worthless, the loan will result in a bad debt for either an accrual or cash basis taxpayer.

Proof of Worthlessness – Proving a debt (or receivable) is worthless requires the taxpayer or business to show that the debt has become worthless and that reasonable steps were taken to collect the debt.

Non-Business Bad Debts – Some bad debts may actually be personal debts, such as personal loans to individuals. In those cases, the bad debt is not deducted as a business expense but is treated as a short-term capital loss on Schedule D instead. The bottom loss for any year on Schedule D is limited to $3,000 ($1,500 for married filing separate taxpayers). Unless the Schedule D contains gains to offset additional losses, a non-business bad debt could be limited to $3,000 per year. The good news is that any amount not deductible in a particular year carries over to the next subsequent year.

If you still have questions, please give us a call for additional information.

During the year, we encounter a variety of questions regarding what expenses are legitimate for business purposes. Below are three questions that we are frequently asked, along with the answers.

Q1 – If a company sponsors an amateur sports team by purchasing the uniforms and the uniforms include the logo of the company, can the company deduct the cost of the uniforms as a business expense?

A1 – Marketing that is intended to portray your business positively can be deducted. Such marketing creates a long-term potential for business and falls within the ordinary and normal requirements of the tax code. Examples of such marketing include sponsoring local youth sports teams, distributing samples of your business product, and costs associated with prizes offered by your business in a contest. As long as your marketing expenses can be reasonably related to the promotion of your business, they can be deducted.

Q2 – If an individual gets traffic citations and parking tickets while traveling on business, can those costs be deducted as a business expense?

A2 – The tax code specifically precludes a deduction for fines or penalties paid to a government including local, state, or federal, and whether or not it is a foreign or domestic government entity. Even though many of these costs are incurred during business trips, they are not considered deductible.

Q3 – Can the cost of subscriptions for business magazines and publications be deducted?

A3 - Yes, the cost of subscribing to certain trade publications related to your business is deductible. However, be careful when taking the deduction. If a check is written out for a three-year subscription today, you are allowed to deduct one-third of the cost this year, one-third the next year, and the final third the year after that.

If you have questions regarding the deductibility of specific items, please call for additional information.

Although marketing and advertising is generally thought of in terms of print ads, flyers and radio and television advertising, they also can include marketing that is intended to portray your business positively. Such marketing creates a long-term potential for business and falls within the ordinary and normal requirements of the tax code.

Examples of such marketing include sponsoring local youth sports teams, distributing samples of your business product, and costs associated with prizes offered by your business in a contest. As long as your marketing expenses can be reasonably related to the promotion of your business, they can be deducted.

Many entrepreneurs and professionals have found it convenient and cost-effective to set up their office or practice in an area in their home. There is no commute time or overhead expenses, and they don’t have to worry about paying someone else office rent. Home-office deductions may be available to these taxpayers whether they are self-employed or employees. What if the taxpayer's business or practice located in the home is incorporated?
Business expenses, such as salary, depreciation or expense deductions for business equipment, supplies and the like, are deductible without regard to the home-office deduction rules and how the business is organized. The expenses that are at issue are the so-called direct and indirect expenses of a home office.

• Direct expenses are those that relate only to the home office, such as the cost of painting the room where the home office is located, or repairing the room's leaking ceiling.
  
  
• Indirect expenses are those that relate both to the personal portion of the home and the business-use portion, that is, the home office. Indirect expenses include items such as utilities, real estate taxes, home mortgage interest, rent, homeowners insurance and repairs benefiting the entire property.

Direct expenses and the business-use portion of indirect expenses relating to a home office within a residence are deductible only if a portion of the home is used regularly and exclusive as:

(1) A principal place of business, or

(2) As a place to meet or deal with customers or clients in the ordinary course of business. Caution: Taxpayers who are employees must meet an additional test—their use of the home office must be for the convenience of the employer.

If the qualification test is met, and gross income from the business use of a taxpayer's home equals or exceeds total business expenses (including depreciation), all expenses for the business use of the home can be deducted. If, however, the taxpayer's gross income from that use is less than total business expenses, home office deductions are limited to the excess of the gross income derived from business use of the home over the sum of:

(1) The deductions allocable to business use that are allowable whether or not the unit (or portion of the unit) was so used (e.g., mortgage interest, real estate taxes, and casualty and theft losses), and

(2) The deductions (such as for salaries or supplies) allocable to the business activity in which business use of the home occurs, but which aren't allocable to business use of the home.

A qualifying self-employed taxpayer claims home office expenses on Form 8829 (Expenses for Business Use of Your Home) and on Schedule C. A qualifying employee enters home office expenses on Form 2106 or Form 2106EZ and claims them as miscellaneous itemized deductions subject to the 2%-of-AGI floor. Note: Miscellaneous itemized deductions are not allowed against the Alternative Minimum Tax (AMT). Thus, if a taxpayer is subject to the AMT, they could lose part or all of the home office deduction benefit.

Problems of the closely held corporation

If the business operated out of a taxpayer's home is organized as a corporation, direct and indirect expenses of the home office are the entity's expenses, not the owner-employee's.

From a tax standpoint, there are three ways to handle these expenses:

• Payment of rent - The corporation can pay its shareholder-employee rent to offset home office expenses and supply him with a return. The rent will be deductible by the corporation, assuming it's a reasonable amount for the space and services actually provided, and will be taxable to the shareholder-employee. However, the shareholder-employee/homeowner won't be able to claim offsetting deductions. The rules allowing deductions for business use of a dwelling unit do not apply to any expense attributable to the rental of all or part of a taxpayer's dwelling unit to his employer during any period in which he uses the rented portion to perform services as an employee of the employer. For purposes of this rule, an independent contractor is treated as an employee, and the party for whom the independent contractor is performing services is treated as an employer. Where such a lease arrangement exists, the only deductions that are allowable are those that could be claimed in the absence of any business use, e.g., mortgage interest, real estate taxes and casualty losses.
  
  
• Unreimbursed employee expenses - The shareholder-employee can satisfy the convenience of the employer test if he is working in the only location of the business. Assuming that he meets the other home-office requirements, the shareholder-employee can claim home office deductions as if he were a qualifying employee of an unrelated corporation, namely treat them as unreimbursed employee expenses on Schedule A. To ward off a possible attack on the grounds that the shareholder-employee is paying expenses he could have sought reimbursement for, there should be a written agreement to the effect that the shareholder-employee is required to pay for expenses. Although this approach appears to be clean, neat and simple, there are a number of unattractive consequences:
  
  o The shareholder-employee can only deduct home office expenses to the extent the total of his miscellaneous deductions exceeds 2% of his AGI—this rule may bar home-office deductions altogether.
  
  o Claiming home office deductions may increase the taxpayer's chances of being audited.
  
  o As mentioned earlier, the deduction is not allowed against the AMT, which could reduce or eliminate the deduction if the individual is subject to the AMT.
  
  o Depreciation deductions claimed for the business-use portion of the home reduces the owner's basis in it, and any home sale gain representing depreciation adjustments attributable to post-May 6, '97 periods isn't eligible for the $250,000/$500,000 home sale exclusion.
  

• Reimbursed employee expenses - The shareholder-employee can treat his home office expenses as if he were a regular employee, and then, by written pre-arrangement with the corporation, have it reimburse him for these costs after he substantiates them in full (amount, time, place, and business purpose of each expense). Results: Assuming the shareholder-employee could have claimed the expenses as business deductions the reimbursement for the expenses is fully deductible by the corporation and is a tax-free accountable-plan reimbursement to the employee. The shareholder-employee avoids having to claim attention-generating home-office deductions, and doesn't have to struggle with depreciation deductions and basis adjustments. However, the shareholder employee can't deduct the business-related portion of his mortgage interest and property tax if the corporation gives him a tax-free accountable-plan reimbursement for these items. Otherwise, he would be getting a double tax benefit—a deduction and tax-free reimbursement—from the same expense.

A home office will be treated as a principal place of business if a portion of the home is used for the administrative or management activities of any trade or business of the taxpayer, but only if there is no other fixed location where the taxpayer conducts substantial administrative or management activities of that trade or business. Deductions will be allowed for a home office meeting this test only if the other applicable requirements of are satisfied—i.e., the home office must be used exclusively and regularly and, in the case of an employee, that exclusive use must be for the convenience of the employer.

The 2008 and 2009 Economic Stimulus Acts include several provisions that will benefit businesses by providing enhanced expensing and depreciation provisions for equipment purchased and placed into service during 2009. This tax relief will encourage businesses to make investments that will enable them to keep growing, and the requirement for investment in 2009 will achieve the stimulus bill's goal of injecting money into the economy right away.

Section 179 Expensing – Code Section 179 allows taxpayers to elect to treat the cost of Section 179 property as an expense deduction for the tax year in which the Section 179 property is placed in service, instead of having to capitalize the expense and recover the cost over several years. Generally, Section 179 property is acquired by purchase for use in the active conduct of a trade or business, and is generally either (i) tangible property to which accelerated cost recovery applies or (ii) computer software (to which depreciation applies) placed in service in tax years before 2011. The property must be used more than 50% for business.

The Economic Stimulus Acts made no changes to the general rules for the types of qualifying property but did increase the 2009 Sec. 179 expensing limits to $250,000, and increased the phase-out threshold to $800,000. The new law does not alter the Sec. 179 limitation imposed on sport utility vehicles, which have an expense limit of $25,000. For 2010, the expensing limits drop to $134,000 and the phase-out threshold is reduced to $530,000.

Bonus Depreciation is Back – For assets purchased and placed in service during 2009, the Economic Stimulus Acts allows trades or businesses to depreciate an additional 50% of the cost of the assets. The types of property eligible for this 50% bonus depreciation will be the same as those included in previous bonus depreciation packages: (1) tangible property that had a recovery period not exceeding 20 years; (2) purchased computer software; (3) water utility property; and (4) qualified leasehold improvement property. The original use of the property must begin with the taxpayer. The bonus depreciation will be allowed under the alternative minimum tax (AMT). This provision does not apply to 2010.

Note: When using both the Sec. 179 expensing and the 50% bonus depreciation on the same asset, the Sec. 179 amount is applied first. Any amount not expensed under Sec. 179 or depreciated under the 50% bonus depreciation is depreciated in the normal manner.

Vehicle Depreciation Limits Increased - For vehicles, the luxury auto limits still apply. However, the limits for 2009 have been adjusted to account for the new 50% bonus depreciation by adding $8,000 to the luxury auto first-year depreciation limit.  The luxury auto cap for 2009 is $2,960, allowing a taxpayer to deduct up to $10,960 for a passenger vehicle (which is the normal cap plus the additional $8,000). For qualifying trucks and vans, the cap increased by $100. When a vehicle is used partially for business and personal use, some prorations will apply. This provision does not apply to 2010. 

Caution – The new 50% bonus depreciation automatically applies unless a taxpayer elects not to take it.

Please call if you would like to discuss how these new tax benefits may apply to your business situation.