Russ Merrick, EA & Associates

If you use independent contractors to perform services for your business or rental and you pay them more than $600 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 2005 tax for the year is $10,000, and your 2005 prepayments for the year total $5,800. The result is that you owe an additional $4,400 on your 2006 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 2004 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. 

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 $300 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). 2007 is the last year this deduction is 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 2007, the credit for single taxpayers phases out between $44,000 and $57,000 and $94,000 to $114,000 for joint filers. Please note that beginning in 2007, this credit will 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. The wages are subject to FICA taxes and 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 plan of your business, allowing you to obtain a business deduction for health insurance premium payments made on behalf of your employed spouse. While maintaining the same family coverage, you increase your business deductions by providing your spouse with family health insurance coverage as an employee. These wages are subject to income tax.
  
• Employing your child. By employing your child, the income tax advantages include obtaining a business deduction for a reasonable salary paid to that child and 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 rules that apply to children under the age of 14. The maximum standard deduction available to your child in 2009 is $5,700 as 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, 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 ($5,750) 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/$24,000 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 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 new tax break. The rules discussed here are applicable to federal tax returns and may not apply to your particular state.

• Eligible Individual – The new 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 new 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 2009, high deductible plans are defined as those with the following deductible amounts:
  
  o Self-only coverage with an annual deductible of $1,150 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, up to $5,800; or
  
  o Family coverage with an annual deductible of $2,300 or more and limits on annual expenses, other than premiums, required to be paid by the plan during the year, up to $11,600.
  
• 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 one-twelfth of the annual limits. For 2008, the annual limits (note these values are adjusted annually for inflation) are either the lesser of the policy annual deductible or:
  
  o $3,000 for single coverage plans;
  o $6,050 for family coverage plans; and
  o $1,000 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 2009. We need to determine his maximum annual contribution limit, which is the smaller of the deductible amount or $4,000 ($3,000 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 $333.33 ($4,000/12). Since John was in a high deductible health plan for 10 months during 2009, his contribution limit for 2009 would be $3,333.30 ($333.33 x 10). If John were in the 25% tax bracket, he would realize a tax savings of $833.

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 increase. 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. 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. 
  
  
• 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.
  
  
• Download files from unknown or questionable sources to a floppy disk.
  
  
• Guard against infected floppies by scanning them with anti-virus software before using them. One of the most popular anti-virus software is Norton AntiVirus 5.0.

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, that limit is $49,000 (up from $46,000 in 2008) and the maximum compensation upon which the contribution is based is limited to $245,000 ($230,000 for 2008). 

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 in 2007. Your car costs $50,000 while your associate's costs $32,000. You both use your vehicles 75% for business. 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. The limitation for 2007 (the limits are subject to change every year) is $3,060. So, your deduction would be limited to $2,295 ($3,060 x 75%). However, your associate will be able to deduct the same amount as you, even though his car had a much lower cost than yours. 

You may already be thinking, "Unfair," and you may be right! Rest assured, for there is an alternative that can help. Certain sports utility vehicles (a Suburban as 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 us 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 $133,000 (down from $250,000 in 2008). The limit is inflation adjusted annually except for the one year boost in 2008 as part of the stimulus legislation.  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.

2008 2009

$250,000 $130,000

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 exceeds the annual limit.  For 2009, the limit is $530,000 (down from $800,000 in 2008).  If married taxpayers file separate tax returns, special rules apply.

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 $10,000 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 55 percent.