Tax debt can be a serious concern for people as IRS will find a way out to retrieve the owed amount from the debtors. Are you struggling to pay your IRS tax debt and frantically looking for debt help? Then an effective debt relief solution can help to eliminate your tax debts. Here are some other options to settle your tax obligations.

• Offer-in-Compromise:

Offer in Compromise is similar to the settlement that you need to propose to the IRS in case you fail to make the tax payment. You offer an amount that is affordable for you to pay off. The IRS will approve or reject the offer after evaluating your financial state. This program saves you from the penalty and interest charges while giving you an opportunity to eliminate your debts.

• Installment Agreements:

Installment Agreement is the best solution to the taxpayers who cannot pay taxes after 120 days of extension. The IRS reviews the financial situation of a taxpayer and then designs a plan accordingly. Paying your tax debt in installment makes it easier for the debtors to pay it off effortlessly. But in this process you are liable to pay off the interest. Time limit of your payment will be legally extended. If you are on installment agreement plan, try to avoid defaulting on your payment because the IRS might terminate your agreement with them.

• Removal of the Penalty:

Penalty charges are levied on the tax debt that you owe to the IRS through an automated process carried out by a computer. Usually these penalty charges are found to be erroneous. In case you find inaccurate penalty charges imposed on your tax debt then you can request the IRS to remove the penalty fee from the owed amount. As a matter of fact, it is advised to consult a tax expert to contest the IRS to remove the wrong penalty charges.

These options can prove to be beneficial to settle your IRS tax debt. You need to select the right option that will be suitable for your financial situation. If you are still confused which option will be perfect for you then consult an experienced and reputable tax debt attorney who will help to make the right choice.

Recently, the IRS has stepped up the aggressiveness of its tactics in pursuing those who hold money overseas, either as individuals or through a corporation or trust, in the hope of catching those who may be evading U.S. taxes or involved in illicit activity.  The IRS has used its clout to play hardball with several foreign banks that have U.S. branches, most famously Swiss bank UBS and English bank HSBC.  In addition, several foreign governments have collaborated with the IRS in revealing the names of U.S. citizens with accounts in their countries.

They

The turning point of these investigations in the requirement by U.S. citizens and residents and the companies and trusts owned by them to file TD F 90-22.1 with the IRS for any year that the combined total of their interest in foreign bank accounts exceeds ten thousand dollars at any moment during the year.  If you are one of the 5 million Americans living overseas or one of the millions more who have signature authority of or an interest in a bank account in a foreign country then you can expect increasing scrutiny from the IRS to ensure that you are fulfilling your legal requirements with the U.S. government; and the penalties for non-compliance can be severe.

Now Is Your Chance to Come Clean

As a consequence of this renewed pressure and increased vigilance by the IRS and to respond to demand, the service has recently launched an amnesty program called the Offshore Voluntary Disclosure Initiative.  In the words of IRS Commissioner Doug Shulman, “as we continue to amass more information and pursue more people internationally, the risk to individuals hiding assets offshore is increasing.  This new effort gives those hiding money in foreign accounts a tough, fair way to resolve their tax problems once and for all. And it gives people a chance to come in before we find them.”

All this honesty comes with a price, however.  The penalty is 25 percent of the amount in foreign bank accounts in the year with the highest aggregate account balance covering the 2003 to 2010 time period; with some taxpayers eligible for special 5 or 12.5 percent penalties.  This is in addition to all back-taxes and interest and penalties for up to eight years.

Who Is Affected

In the words of the IRS, “Any United States person who has a financial interest in or signature authority or other authority over any financial account in a foreign country, if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year. See also Notice 2010-23,  “United States person” includes a citizen or resident of the United States, a domestic partnership, a domestic corporation, and a domestic estate or trust. See Announcement 2010-16.”

A logical question would be, “what the hell does that mean, a ‘financial interest in?’  I own shares of Sony and I’m sure that they have bank accounts all over the world.  Does that mean I have a ‘financial interest in’ those accounts?  I think I’m going get heartburn!”  Well, put down the industrial size Mylanta bottle and stop worrying because, unless your last name is Morita, it is not likely that your interest in Sony stock is sufficient to create a financial interest.  It is generally considered that you must either directly or indirectly own 50% of the account or have signature authority on the account.  An indirect interest means that you own some percent and that the sum of the interests of you and your direct relatives totals to at least 50%. Also, if you control a corporation or other business entity then its interest becomes your indirect interest as well.

Furthermore, note that the requirement is for over $10,000 held at any point in time throughout the year in all overseas accounts.  So if you had $9K at your bank in Malta on  July 4th and $1,001 in the bank in Mexico on the same day but immediately turned around and bought an asset with the Malta money on July 5th then yes, you would have to file and yes, when you filed you would have to list all accounts no matter how small the amount.

What Qualifies As a Foreign Account?

First of all, military banks are not foreign and banks based in U.S. territories like Puerto Rico, Guam, and the U.S. Virgen Islands are also not foreign.  Obviously, banks in the 50 states are not foreign and so a foreign account means an account anywhere else.

So now that we know what is foreign, what is an account?  Well, that would be a checking, savings, money market, and securities accounts.  Note that excluded are “Individual bonds, notes, or stock certificates held by the filer are not a financial account nor is an unsecured loan to a foreign trade or business that is not a financial institution.”

When Do I Have to File By?

Your filing of your TD F 90-22.1 needs to be received by the IRS by June 30.  Note that no extensions are given, unlike an ordinary tax return.  Also, there is no tax due upon filing and so the consequences of filing late are uncertain and probably depend on the IRS and how late it is filed.  If you do file late then you are supposed to include a note as to the reason for your tardiness.

What Happens If I Don’t File?

Failure to comply your obligation to file the TD F 90-22.1 is severe, a $10,000 fine per instance and potential criminal penalties.  In words of the IRS, “Taxpayers who do not submit a voluntary disclosure run the risk of detection by the IRS and the imposition of substantial penalties, including the fraud penalty and foreign information return penalties, and an increased risk of criminal prosecution. The IRS remains actively engaged in ferreting out the identities of those with undisclosed foreign accounts. Moreover, increasingly this information is available to the IRS under tax treaties, through submissions by whistleblowers, and will become more available as the Foreign Account Tax Compliance Act (FATCA) and Foreign Financial Asset Reporting (new IRC § 6038D) become effective.”

Catch Me If You Can

The IRS wouldn’t offer an amnesty if there weren’t still tons of accounts out there whose owners have not complied with the disclosure requirements.  Quite frankly, many of these accounts predate the disclosure requirements and are from a time when the IRS was much less aggressive about enforcement.  Also, before banks were much more likely to guard their account holders’ secrecy and were not as intimidated of  the IRS.  But times are changing and the actions of the IRS against UBS and HSBC have been unquestionably noted by other banks around the world.  Sure, there are probably banks in Iran and Venezuela that would die before giving your information to Uncle Sam, but expect increased compliance everywhere else, including once safe havens like Switzerland.   The world is shrinking and international banking is shrinking right along with it.

Is that an IRS Agent I See Down There?!

As an expatriate American, whether you are sipping a sherry on Spain’s Costa del Sol, hoisting a pint in an pub in Newcastle,  or knocking down a tequila in Mexico’s Riviera Maya, it is comforting to know that you are not forgotten back home in the U.S.A.  Why is it that your Uncle Sam will remember you so easily?  Because every year you must file a tax return with the I.R.S., wherever in the world you may live. Fortunately, for most taxpayers, filing abroad is merely a formality, as the first $91,500 of foreign earned income is excluded from their U.S. taxes and they get a credit for taxes paid to a foreign government.  The danger is in failing to file and risk having the I.R.S. pursue you or even file for you.  So lower your glass, pick up a pencil, and take note of what you will have to do to keep yourself in good standing with your uncle.

When You Have to File

The deadline for paying your U.S. taxes is April 15th, irregardless of whether you live in New York or New Dehli.   However, if you are living overseas you automatically get an additional two months to file your return. Note the difference, any tax due must be paid by April 15th or you could potentially be charged interest.  As with all taxpayers, expatriates have the option of filing Form 4868, giving them a six month extension, until October 15th, to file their return.

How You Get it Done

Again, little changes because of your location.  You will file a Form 1040 along with any supplemental schedules.  For expatriate taxpayers common supplemental schedules include the Form 2555, Foreign Earned Income, and the Form 1116, Foreign Tax Credit.  The Form 2555 essentially means that, if you are a qualifying overseas taxpayer, you won’t owe any U.S. tax on the first $91,500 (2010) of income that you earn from employment or from the operation of your business and the Form 1116 reduces your U.S. tax burden for taxes that you have already paid to a foreign government.

What Information You Will Need

If you are working overseas for a U.S.-based employer, then you will probably receive the same documentation that you would receive if you were based in the States.  If you believe that you will not owe any U.S. tax because your income will meet the requirements of Form 2555 and will therefore not be taxable to the U.S. then it is your responsibility to inform your employer of this so that they will not be required to withhold estimated taxes on your income.  Depending on your country of residence and any tax treaty it may have with the U.S., your employer will withhold payroll taxes just as if you were in the U.S.

On the other hand, if your employer is not a U.S. company then they are not subject to U.S. reporting requirements and will, most likely, provide you only with the documentation required for declarations to a foreign government.  Some common issues are:

• documentation in a foreign language, possibly requiring translation.
• documentation reporting income not on a calendar year, meaning that you will have to do a little extra work to compute your income from January to December..
• income reported in a foreign currency, which must be converted to U.S. dollars for filing purposes.

If You Are Self-Employed

If you own your own business or are self-employed then you may want to finish that drink now, because it gets a little more complex.  Basically, there are two ways to structure your business and each has its own tax consequences.

One way to do it, and probably the most common way, is to run your business through a foreign corporation.  In that case, you are responsible for reporting the wages paid to you (as earned income therefore not subject to U.S. taxes if they meet the requirements of Form 2555) and the dividends (anything paid to you that wasn’t a wage and therefore will be subject to U.S. taxes).  The corporation is a foreign entity and does not have to file and owes no U.S. tax on its income; although you as the owner will have to report your interest it it on Form 5471.

The other possibility is just running your business as a sole-proprietor and not incorporating it.  If your business is not incorporated then you will need to calculate your income and include it on Schedule C of your income tax return.  The income can be excluded on Form 2555 just as income from employment, however it will be subject to self-employment taxes.

Give Me My Drink Back and Get Me Some Help

Most U.S. C.P.A.s and tax preparation services would either turn up heir noses in disgust or run away in fear if presented with the tax return of a U.S. expatriate.  The fact is, it is a specialized service due to the many additional complications that come with filing abroad.  The smart taxpayer makes certain that their provider has the necessary experience before beginning the process.

Basically, there were three big tax acts in 2010: the HIRE Act, the Patient Protection and Affordable Care Act, and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010.  The last of these, we’ll call it the Tax Relief Act, basically kept in place all of the so-called Bush Tax Cuts through 2012.  The second, we’ll call it Patient Protection, will primarily promise higher taxes for some taxpayers in future years, and the first, the HIRE Act has some sweet short term discounts to encourage hiring.

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 in brief

This act was passed primarily to continue most of the tax cuts put in place during the Bush Administration until 2012, an election year.

• 2009 individual income tax rates will be continued for 2010 and through 2012 for all taxpayers.
• 2009 rates on capital gains and qualified dividends will be extended through 2012.
• Payroll rebate – 2% Social Security rebate for employees – The employee’s share of Social Security taxes will reduce from 6.2% of wages to 4.2% for 2011.  Self-employment tax will decrease to 10.4%.  The best part of the deal is that social security benefits will not be affected by discount, although, at some point in time some taxpayers will have to foot the bill for it.
  • What employers have to do – employers “must implement the new rules as soon as possible but no later than January 31,” in the words of the IRS.  If you don’t catch this by the first payroll then you can make an adjustment to the second to compensate.
  • What employees have to do – absolutely nothing.  It is your employer’s responsibility to comply.
• AMT Patch - the exemption amount for the Alternative Minimum Tax is increased to $47,450 for individuals, $72,450 for married taxpayers filing a return jointly and $36,225 for married but filing separately couples.
• Estate Tax – Among the biggest dramas of 2010 has been whether George Steinbrenner’s heirs would inherit his estate without owing any estate tax (“death tax” to you tea party types).  Well, thanks to this bill I can confidently tell you maybe, but probably not.  For 2010 estate managers will have the option of selecting the new regime of a $5 million dollar exclusion with a 35% rate thereafter or of opting under the system that would have a 0% rate but would have denied the “step-up” in basis that inheritors have received under the previous rules.  It gets complicated and few of my readers are passing on >$5 million estates in 2010 (unless you plan on dying tomorrow) but if you want further detail I recommend this excellent resource from CCH.
• Bonus Depreciation – what’s sexier than 50% bonus depreciation?  Try 100% bonus depreciation!  For select fixed assets placed in service from September 9, 2010 through the end of 2011, 100% of the purchase price of the asset may be depreciated in the year of purchase.  For the entrepreneurs with smaller businesses this is important because you can take bonus depreciation even in a loss situation whereas Section 179 cannot put you into a loss.  Also, bonus depreciation could be advantageous with the purchase of a vehicle used for business purposes.

HIRE Act

The HIRE Act was only in effect for 2010 and provided employers with an incentive to hire previously unemployed persons by giving them a 100% reduction on the employer portion of the payroll tax of the qualified hiree.  Furthermore, if the employee remained hired for 52 consecutive weeks then the employer could be eligible for a credit of up to $1,000 per employee.  While it is too late to hire a new employee if you hired someone eligible for the credit don’t forget to apply for the $1,000 credit when they hit 52 weeks!

Tax Planning in 2011

The oldest trick in the book for tax planning is for cash-basis (as opposed to accrual basis) taxpayers, like most of you, to accelerate expenses into the current year through a number of tactics, including accelerated depreciation (like Section 179 or the 100% bonus depreciation available in 2011) or through the purchase of goods and services in the current year that won’t be needed or utilized until the subsequent year.  Alternatively, the taxpayer could delay the receipt of revenue by not sending out billings until the subsequent year.  This is the “kick the can down the road” strategy for taxes; the income will eventually have to be recognized (nerdy accountant speak for saying that taxes will be owed on it) but we would rather that day came later instead of sooner.  Well, the problem with this strategy comes in times of increasing taxes, such as we are likely to enter soon.  All of the above mentioned laws that provide or extend tax benefits are temporary measures that will expire in 2012, an election year.  Most of the political junkies who follow these things would guess that taxes will have to rise in order to keep pace with the gigantic debt the United States is ratcheting up.  If this is the case then in 2011 you could actually find yourself in the position of wanting to prepay your taxes by accelerating revenue or deferring expenses.

An additional tax bill that has already been passed into law, as part of the Patient Protection and Affordable Care Act, and the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, will tack on an additional 0.9% Medicare tax for married filing joint taxpayers earning greater than $250,000 and for single taxpayers earning greater than $200,000 for the 2013 tax year by 0.9%.   In addition, those same taxpayers will be charged a 3.8% Medicare tax on earnings on investments; which were previously not subject to employment taxes.

In conclusion, 2010 was a year of great uncertainty and apprehension regarding taxes for the productive class.  In the end, most tax hikes and any tax reform was pushed further down the road; leaving us with something rather like 2009.  Certain tax hikes are already in the books, albeit not taking effect until further down the road, and taxpayers can expect additional uncertainty in 2012 when the current tax rates expire.

If you need more information that is specific to your problem then contact Tyler here. Remember, it only costs a little bit of time to ask, but the cost of not asking could be devastating.

Tyler Wells, CPA

Watch Your Wallet by Jarnocan

The U.S. citizen and permanent legal resident has the unusual distinction of being one of the only persons on this planet that is taxed on any foreign earned income no matter where she may have earned it.  In fact, legend has it that the first person to greet alien abductees in update New York upon their return to the Earth was an IRS agent, wanting to know what they had received “anything of value or that felt good” during  their abduction and reminding them to include it on their returns.

While the IRS may be led and staffed by life-force sucking Dementors straight out of H… Harry Potter, they do have a practical side and realize the limits of their influence and of the difficulty of getting someone to actually declare the income they have earned abroad.  Therefore, with Congressional support, an exclusion for foreign earned income of potentially 91,500 plus a housing allowance is available for the smaller fish, letting the IRS focus on the larger fish.  And focus they have, increasingly tightening the screws with greater reporting requirements and a less generous exclusion for those who go over the limits.

What is earned income, and how do I know if it is “foreign?”

Earned income basically means that you traded your time and talents for compensation.  That compensation could be in the form of wages, commissions, tips, professional fees, or bonuses.  For it to be foreign you have to have made your “tax home” in a foreign country and have to be either a bona fide residence or physical presence test.  If you meet the tests, then you are allowed to exclude from income for your tax return of up to $91,500 (in 2010) and some housing allowances.  This gets tricky, and I have already covered it in depth in my article on Form 2555.  What is emphatically not the case is that just because you happened to be outside the United States when you earned or were paid income does not mean it can be excluded.

You absolutely ARE required to file

Where you may be located geographically has absolutely no bearing on whether are not you are required to file nor does it matter where you earned your income; you must declare it for U.S. taxes.  Usually, you will file a Form 1040 and will have any number of supplementary forms or schedules depending upon the nature of your income.  For the purpose of income earned from a trade or business while living overseas the proper form is Form 2555.  In addition, if you pay taxes to a foreign government then you would report them on Form 1116 to get a credit on your U.S. tax return for foreign taxes paid.

Social Security and Self-Employment Tax

For the most part, even if your foreign earned income is subject to the exclusion for U.S. taxes by filing Form 2555 you will still owe social security on your wages.  This is subject to several criteria, and the U.S. has Totalization Agreements with a number of countries in order to prevent duplication of taxes (i.e. so that you don’t have to pay into two separate systems).  If you own your own business or are self-employed then this could possibly lead to your having to pay self-employment tax to the United States, depending on how your business is organized.  This is a complicated area and it is important that you get your tax planning done right if you want to avoid paying into social security.  Remember that if you don’t pay money into social security then you don’t get any back out.  If you aren’t saving enough for a rainy day or retirement outside social security then avoiding contributions could potentially come back to really haunt you.

In conclusion, determining whether you income qualifies as foreign earned income is important because, if it is, it may qualify for an exclusion from your income for purposes of filing your United States tax return.  Foreign earned income is coming under increasing scrutiny by the Internal Revenue Service and the taxpayer needs a good plan to minimize their tax costs.

If you need more information that is specific to your problem then contact Tyler here.  Remember, it only costs a little bit of time to ask, but the cost of not asking could be devastating.

Tyler Wells, CPA

The silver lining of this cloud is that the U.S. congress has given the expatriated (and reluctant) taxpayer two weapons to help fend off the avariciousness of the IRS, the Forms 2555 and 1116.  For those actually living overseas, the 2555 is the big gun in the armory, as it allows a direct exclusion of certain income under certain conditions.  Of course, it wouldn’t be U.S. tax law if it was easy to understand, and so I have included here an emphatically NOT by the IRS guide to the Form 2555.

How the Form 2555 Helps You

In its essence, the Form 2555 means that the first $91,500 of income (for 2010) that you earned while living overseas as a resident of a foreign country is subtracted back out of your U.S. income in your tax computation.  For U.S. citizens who live abroad and who make the vast majority of their income through their labor but aren’t business tycoons, professional athletes, or investment bankers this may result in their U.S. tax return being a mere formality with no money due.  “So Tyler,” you ask me, “I don’t make over 91 grand and I’m sure that I don’t owe anything, why should I have to expend the time and money that it would take to file?”  I’ll admit it does seem unfair, but I have to warn that if you don’t file, the IRS can make up a return for you, and it won’t be in your favor!

The Pitfalls of Not Filing

• The statute of limitations never runs out!  Except in the case of fraud or tax evasion the IRS can only audit a tax return three years from the date of filing.  If you don’t file, they can go back forever.
• The IRS can make up a return for you that can be totally erroneous or only include information prejudicial to you.  For example, they will include income without the offsetting expenses or capital gains without showing any basis on the sale.
• The IRS is a mean sonofabitch as a debtor and can garnish social security benefits or retirement plan income in order to pay back taxes that you probably wouldn’t even have owed if you only would have filed!

Additional Benefits to Form 2555

The $91,000 is per person, so if you and the spouse each work then both will file the form.  Also, Congress is aware that many U.S. corporations provide housing allowances for expatriate workers (which they then must include in income on their W-2) and so has added an exclusion for housing allowances which is added on top of the extant $91.5K.  The trick is that the IRS determines the maximum amount of the exclusion based upon the cost of living in the area that you live.  If, for example, you live in Japan and your employer sends you to Tokyo then you get an allowance of a whopping $295.62 per day for a total of $107,900 per year.  On the other hand, if you get sent to humble little Gifu than the maximum allowance that you can exclude is $29,200.  The complete table is available on the instructions for the Form 2555 and makes for some fascinating reading; especially if you’re about to get sent to Moscow, Russia, and you want to know how the cost of living compares to your current post in Doha, Qatar.  Plus, it makes for some excellent tax planning for expats employed by U.S. corporations; your human resources person should claim your salary as housing allowance up to the limit and then everything after that is salary.

Form 1116 Plays Robin to the Form 2555’s Batman

If you’re a high roller and you’ve exhausted your exclusion of $91,500 plus potentially up to $107,900 in housing allowance then you might figure that you are going to owe your old Uncle Sam a share of the pot.  Not so fast, if you are a tax resident of a foreign country then it stands to reason that you also owe tax to your host country. This is where Form 1116 comes along.  It basically gives you a dollar for dollar tax credit for taxes paid to foreign governments.  Of course, being the U.S. tax code there has to be about ten thousand restrictions on what you actually get the credit for, so check out the instructions first.

Am I Eligible to File Form 2555?

To be eligible to file Form 2555 you have to clear two hurdles: first, your tax home is in a foreign country and second, you have to either be a bona fide resident of that country or have had a physical presence in a country or countries outside of the United States.  This gets tricky, so stay with me.

Tax Home Is a Foreign Country

Your tax home is the principal country or jurisdiction in which you carry out your business or employment.  It would therefore be logical that you can have only one tax home at any given point in time and, to qualify for Form 2555, this tax home must have been outside of the United States for at least a portion of the tax period you are filing for.

Bona Fide Resident Test

Once you have established that your tax home was a foreign country for at least a portion of the year that you are filing for, then you must move on to see whether you were a bona fide resident or you meet the physical presence test.  As a generality, if you had a single foreign country as your tax home for the entire tax period and you were residing in that country for a permanent or indefinite period of time then you will choose to qualify as a bona fide resident.
Some factors that could be important in establishing yourself as a bona fide resident:

• Type of visa you entered the foreign country with; does it need to be said that a tourism visa may raise some eyebrows?
• Visa limit stay?  See above
• Maintain home in US while living abroad? if so disclose and explain.  This isn’t a deal breaker but it could signal that your intention was less than that of a permanent or indefinite nature.

Once you have established yourself as a bona fide resident than it is assumed that you continue to be a bona fide resident until you establish otherwise.

Physical Presence Test

If you don’t meet the criteria for being a bona fide resident of another country, then you can look to the physical presence test.  To qualify, you must have lived outside the US for at least 330 days of any period of 12 months in a row.  There are lines on the form (line 16) that you will need to fill out showing what countries you were resident in and for what dates.  Generally, the physical presence test will be useful to those who have moved outside of the United States but were not established in their country of bona fide residence as of the first day of the tax year, for those who were outside the U.S. but in multiple jurisdictions, and for those who have a job or vocation that has taken them outside the country but who fail to meet the semi-permanent or indefinite period requirement.  An important point to note is that you don’t have to have met the 330 day requirement by the end of the tax year, but by the filing date, including extensions.  Also, if your period outside the United States extends into subsequent periods then you could be allowed a pro-rated amount of the exclusion.  For example, if you move to England on July 1, 2009 and stay there through July 1, 2011 then you could possible qualify for one half of the amount of the exclusion for 2009, the entire amount for 2010, and one half for 2011.  As you can imagine, it is much more complicated than that and you might find that you don’t qualify for any of the exclusion for any of these periods.  See the instructions to Form 2555 and Publication 54 for details.

Can I Exclude Income from My Investments?

No, Form 2555 only helps for income earned from your employment or from your trade or business while qualifying under the tests above.  If you have paid tax to another government on your foreign investments then you may be able to take a credit for that on your form 1116.

In conclusion, the expatriated American has recently earned increased scrutiny from Congress and the Internal Revenue Service.  For most Americans, however, avoiding unnecessary taxes can be a fairly straightforward matter thanks to the ability to exclude their foreign sourced earned income on Form 2555
Please leave your questions or offer your solutions below. As the WebCPA and the author of WebBizFinance.com, my job is to help you grow your business and solve your business finance and accounting problems!

Tyler Wells, C.P.A.

Crazy about Blogging

Hey guys, I have the honor of having a guest post on FitBlogger’s Guide on taxes for bloggers. Actually, I think the principles apply to almost any online business person. So please take a look and leave a comment!

Your Burden of Proof

Most of us have watched movies or Law and Order episodes that hinged upon the valiant police officer/prosecutor/insert your hero here having to find evidence to put away the bad guys because, the show explains, the burden of proof rested with them.  In the world of the taxpayer and the IRS that relationship is turned on its head.  You’re the hero, and the evil IRS is out to get you.  Only they can accuse you of whatever they want and you have to prove them wrong or you get big fines and go to jail.
Our hero’s (that you!) best defense against the tyranny of the IRS is to build a fortress of excellent bookkeeping and quality document retention.  Almost sounds romantic and adventurous when I say it that way!  Well, keep in mind that I am an accountant.  Anyway, the taxpayer must be able to prove that all expenses claimed, first, actually took place, and second, were for the benefit of the business.  So its not enough to have that shoe box of receipts.  You’ll also have to put those receipts together into some sort of coherent statement in order to be able to complete the Schedule C and to back up that the receipts actually do have a business purpose.

Who Has To File a Schedule C?

Independent contractors, unincorporated small businesses, and single member LLCs (a business organized as a limited liability company that only has one owner) report their income from operations on the Schedule C.  Keep in mind that the IRS makes a very important distinction between income earned from investments and income earned from the operation of your business or your labor.  This is extremely important to you because income from the Schedule C is generally subject to self-employment taxes.  Generally, the distinction is clear cut but at times there can be grey areas, such as in the case of real estate professionals who renovate, rent and sell houses both for themselves and for others.  In a case like that they will probably end up filing Schedule C for some of their activities and Schedule E (for investment income) for others.

Who Doesn’t File a Schedule C?

The IRS specifies that the activity on the Schedule C can only be for the operation of your business or profession.  Therefore, there has to be an intent to make a profit; meaning it is not a hobby.  This is important to you because you can deduct your business losses against other income (like wages) and therefore the IRS is very keen on re-characterizing losses from your business as hobby losses, and therefore not deductible against your other income.

Tricks and opportunity of Schedule C

In my experience the number one way most entrepreneurs lose on business deductions is by being too busy or too lazy to keep good records and thereby forgetting about deductions that they have every right to take.  Remember this, by law everyone is keeping track of the money that they pay you but only you are responsible for keeping track of the money that you pay out.  So get yourself some software or a basic accounting system or hire someone to do it for you.

Your rich Uncle Sam has, however, thrown the small business owner a few bones.  A few of the sexiest and most useful are listed in brief below, along with links for more information.

• The use of your car for business- you’ve got to get supplies, meet clients, and run errands, right?  Most entrepreneurs don’t have the cash to buy a car just for their business and so Sam gives them the opportunity to keep a log of their miles and then deduct the total miles at a specified rate at the end of the year.  For 2010 that rate is $0.50 per mile. The key here is documentation.  You are required to keep an actual log that must specify both the miles driven and the business purpose of the trip.  In this day and age some people like to print up a Google map of every trip, jot down the business purpose, and throw it in a file.

• The use of your home for business- Have you dedicated a room or a portion of your home for strictly business purposes?  If so you can deduct the expenses of maintaining that area, including even depreciation, on your Schedule C (by way of Form 8829).  Now, our dear Uncle Sam has noticed that  a large number of taxpayers have taken certain liberties with this deduction and, as such, it has become a real hot button issue for the IRS.  They, with the help of Congress, have tightened down considerably to beat out some of the shenanigans and the result is that this is no longer so attractive as it once was.  Still, if you have a room, out building, or portion of your home and you can prove that you exclusively use it to conduct your business, it is worth your while to do some further investigating.

• Your retirement- Perhaps the greatest deal in the history of taxes is the tax-advantaged retirement plan.  The government is paying you to do something that you absolutely need to do anyway!   I could go on about the incredible opportunities this presents at length but, fortunately for you, I already have!  So check out WebBizFinance.com for the inside information.

• Your health- If you maintain a total media blackout and live under a rock out in the Sonora Desert then you may not have yet heard that the U.S. government is becoming increasingly involved in health care.  “But Tyler, where do I go for informative and meaty yet fun and light ideas on affording health care as an entrepreneur,” you ask.  Why, WebBizFinance, of course!

Gotcha! Red Flags and Traps for the Unwary Taxpayer

I am not a big believer in tiptoeing around your tax return because you’re afraid that taking a certain deduction might throw up a red flag for the IRS.  I do believe that you should keep great documentation and solid financial records and then be very aggressive in deducting everything that has at least some legal basis.  However, we don’t live in a perfect world and some of you, you know who you are, have waited until the ending of the year and are desperately putting together your financial statements to prepare your income taxes.  For you a fascinating tool is BizStats.com, a site that allows you to look at the deductions of comparable businesses and see how in line your deductions are with other business owners.  This can also help remind you about some expenses that you may have overlooked or forgotten.

Schedule SE, Self-Employment Tax

One of the biggest “Oh my God!  I didn’t budget for that!” horrors for new entrepreneurs is self-employment tax.  For Schedule C filers the amount from the bottom line, you net income, from you Schedule C gets transferred to Schedule SE, reduced by 7.65%, and then multiplied by by 15.3% for the first $106,800 of your income.  Yeah, that’s a big bite!  The good news is that part of that counts toward your social security benefits, the bad news is that you have to cough up the dough now for a rather uncertain future benefit.

Down the Schedule C, Line by Line

1. Basis of accounting – accrual vs. cash – 90% of Schedule C filers will choose the cash basis of accounting, because that is generally the best method for them.  Look, don’t let this get confusing.  The rest of you tax return is on a cash basis and so you may as well have your business that way as well.
2. Material Participation – material participation just means that you actually provided some work to this enterprise.   If not, you probably shouldn’t be filing on a Schedule C.
3. Cost of Goods Sold – The cost of goods sold section on page 2 primarily applies to wholesalers, retailers, and manufacturers.  The basic concept is that you should not get a deduction for an item that you plan on selling in the future, which is really legitimate, to be fair.  Instead, you have to capitalize that

Special Expenses

1. Car and Truck – as mentioned above by far the most common method of deducting your transportation is through the use of your personal vehicle for mileage.  However, if you have a delivery truck or a vehicle that is used exclusively for business purposes then you can put that vehicle on the books and then deduct interest and all direct expenses for the vehicle.
2. Depreciation & Section 179 – Section 179 is one of the sweetest deals for small business.  Normal depreciation rules require you to capitalize all goods that you buy that are not expressly for the purpose of resale or to be used in construction or manufacturing by putting them on the books as a fixed assets, instead of expensing them and deducting them for your tax returns.  You then depreciate (take as an expense) a portion of the amount each year, depending on a mind-boggling number of factors.  With Section 179, however, you get to deduct the full amount of most items as an expense in the same year in which you buy them, a sweet tax planning tool.
3. Employee Benefit Programs – see above
4. Deductible Meals and Entertainment – Your business expenses for meals and entertainment are 50% deductible.  This means that 50% of what you spend can count against your income taxes.  Be aware, this area has been heartily abused by taxpayers in the past and so the IRS is really stringent with the requirements for documentation and explanation.  Meaning that it is not enough to have a receipt for a restaurant; you have to say who you met with and what the business purpose of the meeting was.
5. Expenses for business use of home (whole other post)- see above

Foxymoron: Sarah wants to save you money!

What’s Self-Employment Tax?

Self-employment tax is 15.3% of your first $106,800 of earned income and then 2.9% for every buck after that (2010 rates).  In return, your self-employment wages are included in the equation to calculate your benefit from social security; the higher those wages, the higher the benefit you will receive (in general and up to a point).  If this still leaves you hungering for more information then this page on the IRS website should satiate you.

Who Has to Pay It?

The tax for self-employment is levied on net earnings from your business.  If you are reporting your business income on a Schedule C then it will be the bottom line (31 in 2009) of the return.  If you file a Schedule C (Profit or Loss From Business),  a Schedule F (Farming), or a Schedule E with income from a partnership then you will need to file Schedule SE and, if you have more than $433 total income from all the above sources then you will have to pay self-employment tax.

Who Doesn’t Have to Pay It?

Self-employment tax is on earned income from your labor and so it must follow that investment income is not subject to self-employment tax.  Capital gains, interest, dividends, and most rents and royalties are therefore excluded.  Notably, income from a Subchapter S corporation (S Corp) are also excluded on the grounds that they are investment income and not self-employment income.  Many business entities could easily qualify to be organized as either a partnership or an S-Corp and so the opportunity to avoid self-employment tax has been a factor that has made the S-Corp very attractive as an entity.

How to Minimize or Avoid It

Thinking back to the type of income that is subject to self-employment.  If you want to reduce or avoid the tax therefore, you need to have a legitimate reason to recognize your income as excluded in nature.  A popular method for doing this is to charge your business rental income for the use of your real property.  Let’s say I own a small office building where I do most of my tax and accounting work.  I have my office building charge my professional practice rent and thereby effectively and legally (when done right) characterize some of my income as free from self-employment tax.
I will tell you right now that this is a big factor overlooked by many self-employed and entrepreneurs, who have a tendency to lump every bit of income into the same basket.  Paying attention and doing some tax planning could save some bucks here.
As noted above, income from an S-Corporation is not subject to self-employment taxes.  That’s the good news.  The bad is that the IRS demands that the owners pay themselves wages (subject to payroll tax, which is essentially the same as self-employment tax) in order to close this loophole somewhat.  Also, there is noise charging self-employment tax on S-Corporations earnings, so you run the risk of going through trouble of making your business an S-Corp and then having the exemption pulled right out from under you.

What This Means to You

Regular income tax is graduated, meaning that the rate of the tax increases as the amount of the income increases.  Due to this graduation many low income filers owe very little tax, no tax at all, or even get money instead of paying when they file a return!  Self-employment tax, however, is on a straight percent of earnings (up to the $106,800 limit, at least) and therefore if you clear the $433 hurdle then you will pay it.  This can come to a shock to the newly self-employed and to smaller operators who are making enough to keep things afloat but have never really had to pay income tax due to their low incomes.  Also, it would make you cry to see how many first year independent contractors have not budgeted for the tax and get a hefty bill at the end of the year when they are used to a refund.
Self-Employment tax may be calculated differently from regular tax, but it is collected the exact same way.  This means that you will need to make quarterly estimates on your tax obligation you and, if the estimates aren’t enough or if you don’t pay them, you could be subject to interest and penalties.  Again, if you income fluctuates from year to year or if you have had a major deal or a gigantic sale go through, revisit your planned estimate payments to see if they don’t need to be increased.

A Tax You May Actually WANT to Pay!

I have clients that I strongly discourage from reducing their self-employment tax.  Tabloid headline: Accountant tells his clients to pay more tax! Before you get all bent out of shape and sic Sarah Palin on me hear me out.  If your income is low and your retirement contributions are also low or nonexistent, Social Security might be what keeps you off the bread line when you retire.  For taxpayers in this situation, contributing to Social Security is a positive benefit and beyond a shadow of a doubt better than nothing at all.  So hesitate before you cut that payment too low.

Watch Your Wallet by Jarnocan

When you cook, do you consult the recipe book after having already prepared the meal?  When you have sex, do you wait until you’re done to put the condom on?  What about, do you starting preparing your tax return after the end of the year?  What do you mean, “two out of three ain’t bad?!”

Want to shocked and awed with fascinating information on reducing your tax bill and saving some money? Check out my guest post on Noobpreneur.com!