Monthly Archives: August 2013

Should you choose LLC status for your business?

Are you thinking of making your new business a limited liability company? You’ve probably already learned that an LLC combines the limited liability protection of a corporation with a partnership’s flexibility in allocating income and other items among owners. However, you may be wondering how that hybrid status affects your taxes. For instance, would you file as a corporation or a partnership — or something else?

The answer is: You get to choose. When you’re the only owner, or member, of your LLC, the default entity for federal tax purposes is a sole proprietorship. You attach a Schedule C, E, or F to your individual return to report business activity and pay income and self-employment tax.

You can also opt to file as a corporation, either a “C,” or an “S.” To elect C corporation status, complete Form 8832, Entity Classification Election. To elect S corporation status, you must file Form 2553 by March 15 of the year you want S status to begin. At year-end, report your business income on Form 1120 or 1120S.

When your business has multiple members, it’s considered a partnership, unless you elect corporate status by filing Form 8832 or Form 2553.

Deciding how to organize your business is not a one-size-fits-all process. While you can change your mind later, doing so may have tax consequences. Give us a call. We’re here to help you figure out the right fit.

Do mutual fund tax planning

Are mutual funds part of your portfolio? As you begin your late-summer investment review in preparation for year end, think about how your funds can affect your federal income taxes.

Here are two things to consider.

  • Dividend income. The dividends you receive from mutual funds held in nonretirement accounts are included in the calculation of net investment income. When your 2013 modified adjusted gross income exceeds $250,000 ($200,000 when you’re single), a portion of your net investment income will be taxed at a rate of 3.8% over and above your ordinary tax liability.

    Planning tip. The tax form the mutual fund company sends you at the beginning of 2014 may classify some dividends as “qualified” — meaning they meet the requirements for a lower tax rate. However, you have to own the mutual fund shares for more than 60 days to get the lower rate on your federal return.

  • Capital gains. Mutual funds generally distribute short-term and long-term capital gains from in-fund sales to shareholders. Even if you reinvest the distributions in additional shares instead of opting for cash, the gain remains taxable to you.

    Short-term distributions, for sales of fund investments held one year or less, are taxable at your ordinary income tax rate. The tax rate for long-term capital gains may be as high as 20%, depending on your adjusted gross income.

    You might also have a capital gain or loss when you sell shares of a mutual fund. That’s true even if you “exchange” one fund for another and receive no proceeds.

    Planning tip. You have options for calculating the cost of mutual fund shares you sell during the year. Remember to include reinvested distributions in your basis.

Please call for more information. We’re happy to help you manage your investments with an eye toward tax savings.

Interest rates can affect your taxes

Do you keep up with fluctuations in interest rates? The IRS does too, and changes in those rates could affect your tax return. For instance, applicable federal rates, or AFRs, are published by the IRS to set a minimum interest rate for certain transactions, such as loans to family members.

How does that affect you? Loans you make that carry an interest rate lower than the market offers can be considered a taxable transfer for income and gift taxes. The result: You might have taxable income even if you receive no interest, and a gift tax return may be required. Not reporting the income or not filing a gift tax return when necessary, could lead to penalties.

Establishing a written loan agreement with a stated interest rate — for example, the AFR in effect for the month of the loan — helps avoid misunderstandings.

The IRS also publishes interest rates that apply to the underpayment and overpayment of your taxes.

Say you get a notice increasing the liability on your federal return. You’ll generally owe interest from the due date of the return until you make payment. The interest is compounded daily, and applies to penalties as well as to the underpaid tax.

Interest rates can provide opportunities for planning, including strategies for making transfers of your business to family members and charitable trusts. Please call if you need additional information.

Work-related education expenses can be deductible

Are you going to school this fall to earn an advanced degree or to brush up on your work skills? If so, you might be able to deduct what you pay for tuition, books, and other supplies.

In general, when you’re self-employed or working for someone else, you can claim a deduction for out-of-pocket educational costs if the training is necessary to maintain your skills or is required by your employer.

A caution: Even when the education meets those two tests, if you’re qualified to work in a new trade or business when you’ve completed the course, your expenses are personal and nondeductible. That’s true even if you do not get a job in the new trade or business.

Because it’s often difficult to determine whether some degrees, such as an MBA, qualify you for a new trade or business, you’ll need to look at your specific situation to decide if you can claim a deduction. One useful test is to compare the work you were able to perform before the education to what you are qualified to perform afterward.

Work-related education expenses are an itemized deduction when you’re an employee and a business expense when you’re self-employed. You may also be eligible for other tax benefits, including the lifetime learning credit or the tuition and fees deduction.

To learn more, please call our office.

Track your IRA basis

Are you thinking of making your new business a limited liability company? You’ve probably already learned that an LLC combines the limited liability protection of a corporation with a partnership’s flexibility in allocating income and other items among owners. However, you may be wondering how that hybrid status affects your taxes. For instance, would you file as a corporation or a partnership — or something else?

The answer is: You get to choose. When you’re the only owner, or member, of your LLC, the default entity for federal tax purposes is a sole proprietorship. You attach a Schedule C, E, or F to your individual return to report business activity and pay income and self-employment tax.

You can also opt to file as a corporation, either a “C,” or an “S.” To elect C corporation status, complete Form 8832, Entity Classification Election. To elect S corporation status, you must file Form 2553 by March 15 of the year you want S status to begin. At year-end, report your business income on Form 1120 or 1120S.

When your business has multiple members, it’s considered a partnership, unless you elect corporate status by filing Form 8832 or Form 2553.

Deciding how to organize your business is not a one-size-fits-all process. While you can change your mind later, doing so may have tax consequences. Give us a call. We’re here to help you figure out the right fit.

What if you have a casualty gain?

You’re probably aware you can claim a deduction on your current or prior year federal income tax return for casualty losses from sudden, unexpected, and unusual events, such as tornadoes, hurricanes, and certain straight-line winds.

But what if you have a casualty gain?

Odd as it sounds, when the reimbursement from your insurance company or other payor exceeds your adjusted basis in damaged property, you have an “involuntary conversion gain.” An involuntary conversion is treated as a sale and can result in taxable income. That’s true even when the property is your personal home, assuming the gain is more than your allowable exclusion.

Whether the gain is currently taxable depends on several factors. For example, you could choose to replace your damaged property with similar property. Making the election allows you to postpone all or part of the tax.

In general, you have two years to replace damaged property, and you may be able to request an extension for an additional year. If your location is declared a federal disaster area, you have up to four years to make the replacement.

Please call for more information about casualty gains and losses. We’ll help you get the most beneficial tax treatment.

Build your credit wisely

Few Americans can afford to pay cash for everything they want or need — a car to get to work, a house to live in, or a college education to increase earning potential. For most people in our modern society, some form of credit has become a necessity. And the way in which a person’s credit history is established often affects the interest rates that lenders are willing to offer and the likelihood that loan applications will be approved. So it’s important to build credit wisely.

Following are three tips to help establish your credit worthiness in the eyes of potential lenders.

  • Cash is still king. Just because a financial institution offers to extend credit, don’t forget that it’s often wiser to defer purchases until later. Pushy sales people may claim that you can “afford” the minimum monthly payments on a luxury automobile that costs more than a lakeside bungalow. But when your bills stretch the limits of every paycheck, you may be headed for financial disaster. Ironically, avoiding certain debts is often a prudent way to establish good credit.
  • Take it slowly. Apply for one credit card, use it sparingly, and pay off the balance every month. That’s the golden rule for bolstering your credit score. Opening multiple accounts over a short time may signal to lenders that you’re overextended. When you take out a loan for a car, make sure you can meet the monthly payments even if your other expenses spike in a given month. In other words, establish some wiggle room in your budget. Don’t assume that expenses will always remain at current levels. Emergencies happen. Plan for them so you don’t end up missing a minimum payment on a loan or credit card bill.
  • Beware of increased credit limits. As your credit score climbs, banks and other financial institutions will likely allow you to borrow more. Use caution. Remember that lenders have a vested interest in lending money to folks who pay on time. When you take out loans, they make money. Maybe you can borrow; that doesn’t necessarily mean that you should borrow. Again, the choice to acquire debt in the form of loans or credit card purchases should be driven by a plan — not an impulse.

For more ideas about building strong credit, give us a call.

How to reduce inventory risk in your business

Study the balance sheet of most retail or manufacturing businesses, and you’ll find inventory near the top of the asset list. Accountants define inventory as raw materials, supplies, work in progress, and finished goods. It’s the stuff sitting on shelves, parked in the lot, or being produced in the factory — merchandise that managers expect to sell in the normal course of business. Buying, storing, handling, and insuring that stuff is expensive. As a high-value asset, inventory often represents a significant risk, and mitigating that risk is crucial to maintaining profitability.

To reduce inventory risk in your business, consider the following:

  • Too many or too few goods. Nothing beats a comprehensive and consistently applied inventory tracking system for making sure you don’t overbuy from vendors or underestimate the needs of your customers. The best information systems will capture detailed sales histories and forecast demand with reasonable precision. In addition, regular contact with customers may help to identify emerging demand or dissatisfaction with existing products. These conversations, in turn, can influence your inventory purchase decisions.
  • Obsolescence. Most inventory declines in value over time. To mitigate this risk, a manager should track revenue data and regularly move inventory via special promotions, discounting, and sales. Paying to hold and insure obsolete merchandise drains profits. Make room for fresh inventory by creatively moving the inventory that’s already on your shelves.
  • Damage. Managers should identify the causes behind frequent damage. Perhaps employees need better training in handling goods; perhaps more stringent policies need to be set. Some clothing retailers, for example, limit the number of boxes that can be stacked on pallets. Maybe the company’s packaging is not sturdy enough, or a change of suppliers is warranted. Knowing why your inventory is being broken is the first step to reducing that risk.
  • Theft. Establishing physical safeguards — locks, lighting, fences, cameras, and the like — can help protect merchandise, whether it’s housed in the store or warehouse. Taking time to perform thorough background checks on employees may also reduce fraud risk. Hiring an independent auditor to review inventory levels is often a good preventive control, a control that sometimes ferrets out theft. If employees know that management routinely checks the company books and counts inventory, they may be less likely to shuffle goods from the warehouse to their homes or engage in “creative” accounting.