Tax Trap #2 -- Double Taxation: Isnt Once Enough?

Have you been thinking about incorporating your small business or self-employment activity? The advantages are many!

For starters, you'll be protecting yourself and your family from the possible of a business ending lawsuit. Forming a corporation is Step One on the path known as "Asset Protection" -- you are moving from the world of unlimited liability to the world of limited liability.

(NOTE: For further insight into the legal advantages of incorporating, check out the article: "It Can Happen To You: Why Any Sole Proprietorship Is A Risky Business" at http://www.YouSaveOnTaxes.com/happen-to-you.html)

From a tax standpoint, there are both advantages and disadvantages to incorporating. Yes, forming a corporation can either reduce your taxes or increase your taxes, depending on what type of corporation you create.

There are two main types of corporations: "C" Corporations and "S" Corporations -- and which type you choose can make all the difference in the world of taxes.

NOTE: The question of "C" Corp vs. "S" Corp has no effect on the asset protection provided by your corporation. This is a tax issue, not a legal issue.

A "C" Corporation can lead you into a Tax Trap known as "double taxation". Yes, income from a "C" Corporation can actually be taxed twice -- once when it's earned on the corporate level and again when it's paid to you, the shareholder, in dividends.

There are several ways to avoid double taxation. Often the easiest way is to tell the IRS that you choose to be an "S" Corp instead of a "C" Corp. The profits of an "S" Corp are not taxable to the corporation; instead, those profits are reported directly on the shareholder's personal income tax return and are therefore only taxed once.

And once is enough, don't you think!

Of course, any article on Choice of Entity must contain the old disclaimer, "Consult your tax professional" -- I am not prescribing a one-size-fits-all approach to this issue. But for many small biz owners and self-employed folks, the "S" Corporation is a good fit because it provides protection from personal liability and avoids the nasty tax trap of double taxation -- two great benefits worth checking into.

Should you incoporate your sole proprietorship and then decide that the "S" Corporation is the right fit, you must inform the IRS that your corporation is choosing "S" Corporation status by filing Form 2553, which is, in effect, an application to become an "S" Corporation.

IMPORTANT: If you incorporate and do not file Form 2553, you are automatically considered to be a "C" Corporation by the IRS. In other words, to be a "C" Corporation, you just incorporate; there is nothing you have to do to inform the IRS you want to be a "C" Corporation.

There are critical rules regarding how and when to file Form 2553, so be sure to read the instructions carefully, or check with your tax pro.

Failure to file Form 2553 on time or filing Form 2553 incorrectly results in a rejection of your corporation's "S" Corp application, and the corporation is then by default treated as a "C" Corp, subject to double taxation, the very trap you were trying to avoid.


By Wayne M. Davies

How to Check the Status of Your Tax Refund Online

So, you were pleasantly surprised to learn that you are getting a refund on your taxes. Congratulations! The question for most taxpayers expecting a return is, "Where is my refund?"

Check Your Refund Status Online

The easiest way to check on your refund is to ask the IRS through IRS.gov. On the home page of the site, you will see a "Where's My Refund?" link. Using the service is fairly easy. You will need a copy of your tax return to provide the necessary information to get the status of your refund. Specifically, you need to provide your social security number, you tax filing status and the exact amount of your refund. The reason the IRS requires all of this information is purely for security purposes, to wit, the agency wants to make sure it is giving access only to the taxpayer. Again, all of this information should be on your return. If it is not, something is very wrong!

Once you submit the required information, the IRS will provide online results typically showing:

1. That the return was received and is in processing;

2. The expected mailing date or direct deposit date of your refund; or

3. Whether your refund could not be issued because of a delivery problem.

In some cases, the results may alert you to the fact that the IRS is reviewing your tax return because of errors or questionable entries. In such a case, it is highly advised that you review your return with a qualified tax professional and make absolutely sure that the return will stand up to scrutiny.

How Long Do You Have To Wait Before Checking?

If you filed your tax return electronically, you should be able to access the status of your refund within 48 to 72 hours. Since the return is coming into the database electronically, it should be assimilated into the system fairly quickly. If you do not file your return electronically, you are going to have to wait three weeks or more before the status of your return can be checked. As you can imagine, the IRS is receiving an enormous amount of paper tax returns and it takes time to organize and enter the returns into the system.

How Long Should It Take To Receive Your Tax Refund?

If you are expecting a refund, the time to issue the refund will depend upon how you filed your return. If you filed a paper return via regular mail, you refund should be issued in six to eight weeks from the date it was received by the IRS. Alternatively, if you filed your return electronically, you should expect to receive your refund in three to four weeks. If you elected to have your refund directly deposited in your banking account, you should take one week off of the above estimates.


By Richard Chapo

Tax Trap #4 -- The Quagmire of Depreciation

If you are a Small Business Owner or Self-Employed Person, there's one especially lucrative tax break that not only puts money in your pocket, it also makes the filing of your business tax return much simpler.

What am I talking about? It's called the Section 179 deduction, and if there's one tax break you need to understand, this is it. Here's why:

The Section 179 deduction enables the Small Business Owner to "expense" (i.e. deduct in the current year) up to $102,000 of the cost of most business equipment, rather than use those stingy and complicated depreciation rules that require you to write-off the cost over five or more years.

What's so great about that?

Think about it like this: I've got a dollar and I'd like to give it to you. You have two choices -- I give it to you now, or I give it to you 5 years from now.

Which do you prefer?

Obviously, you'd rather have it now, right?

And why is that?

Because of what you learned way back in Finance 101: something your banker calls "the time value of money."

I'll spare you a boring textbook definition. Instead, let's just assume we agree on this simple point: Is a dollar worth more today or 5 years from today?

It's worth more today.

And that's why the Section 179 deduction is so valuable.

Huh?

Let's use an example to bring all this financial theory into reality.

You buy $5,000 worth of office equipment in 2004. Under normal depreciation rules, you wouldn't get to take a deduction for $5,000 in 2004. Instead, you'd write off the $5,000 over 6 years -- part in 2004, part in 2005, etc.

If you're in the 35% tax bracket, you get your $1,750 in tax savings over 6 years. Yawn. That's a long time!

You'd get your deduction, and the resulting tax savings, but you'd have to wait 6 years to realize all the benefits.

Section 179 says that if you meet certain requirements, you can deduct the full $5,000 in 2004. You reduce your taxes by $1,750 in Year 2004.

So let me repeat my rhetorical question: Uncle Sam has $1,750 he'd like to give you. When do you want it? All at once, or spread out over 6 years?

That's the beauty of Section 179.

But you have to meet certain requirements to benefit from Section 179. One requirement concerns the total amount of equipment you can deduct rather than depreciate. In 2002, the amount was $24,000. And for 2003, the amount was originally set at $25,000.

Then Congress and the President passed a new tax bill in late May 2003 that raised that amount to a whopping $100,000. And since that $100,000 gets adjusted for inflation, in 2004 the maximum Section 179 deduction is now $102,000.

Never liked depreciation? Well, you can pretty much kiss it good-bye now. If your business buys more than $102,000 of equipment in a single year, it ain't so "small" any more! So this new law should cover all small businesses. Enjoy!

One final note: A few other requirements must be met to claim the Section 179 deduction. Here's a brief, but not comprehensive, overview:

1. Most personal property used in a trade or business can be deducted via Section 179. Real property cannot. Typical examples of personal property include: office equipment such as computers, monitors, printers and scanners; office furniture; machinery and tools. Real property means buildings and their improvements.

2. The $100,000 amount (adjusted for inflation) can be used through 2007. In 2008, unless new legislation is passed, the amount goes back down to $25,000.

3. There are special rules regarding the application of Section 179 to the purchase of business vehicles. (Where there are tax breaks, there are always expections!) For example, the special "SUV rule" that allowed 6,000 LB vehicles to be fully deducted (up to the $100,000 amount) was recently changed to $25,000, effective October 22, 2004.

4. Your total Section 179 deduction is limited to the business' annual profit. In other words, you cannot use the Section 179 to create or increase a loss.

This is known as the "taxable income limitation." For "C" Corporations, this limitation is very cut and dried. But if your business is an "S" Corporation, Partnership, LLC, or Sole Proprietorship, it may not be as limiting as it seems. For these non-"C" Corp businesses, the Section 179 deduction can be used to offset both business and non-business income.

And if you're married filing jointly, the Section 179 deduction can offset your spouse's income, including W-2 income.

Example: You start a new business in 2004 that ends up with a loss for the year of $5,000 (before taking the Section 179 deduction). Your spouse has W-2 income of $60,000. Even though your business is unprofitable, you can still take the full Section 179 deduction of $5,000 (again, assuming your business is an entity other than a "C" Corporation).

Be sure to consult with your tax professional to get the scoop on all the Section 179 rules.

By Wayne M. Davies

How To Get An Extension To File Your Business Tax Returns

Yes, the tax season is upon with the first filing date for some businesses being March 15, 2005. If you can't imagine getting your tax returns together by that date, you need not worry. The IRS automatically gives you an extension if your file the appropriate form. As you might expect, there are different forms for different businesses.

An Important Note

It is vitally important that you understand that an extension to file taxes is not an extension to PAY taxes. The IRS will give you a break on the filing date, but it wants the money now! If you anticipate that you will owe taxes, you need to send in the appropriate payment. Failure to do so could result in interest charges when you eventually get around to filing your returns.

Corporations

If you conduct business as a corporation with a fiscal year-end of December 31st, you are required to file your 2004 tax returns on or before March 15, 2005. You can get an automatic extension, however, by filing form 7004 before the March 15 deadline. Form 7004 applies both to "C" and "S" corporations and grants you an automatic 6-month extension to September 15, 2005.

While this automatic extension applies to "S" corporations, you should be aware of a quirk in the tax code. Since "S" corporations "pass through" taxes to your personal returns, the six-month extension is really only a five-month extension. To file your personal tax returns, you must report information from the K-1 issued from the "S" corporation. Unfortunately, the IRS only grants automatic extensions for filing personal tax returns to August 15, 2005.

Limited Liability Company

The IRS has never really figured out to how to handle limited liability companies. It has settled on a policy of avoiding the issue and simply treating the entity as a corporation or partnership.

Limited liability companies with more than one owner typically elect to be treated as partnerships for tax purposes. If this describes your situation, the LLC is required to file tax returns by April 15, 2005. You can obtain a 3-month extension by filing form 8736. Although form 8736 contains language regarding partnerships, you will still use this form since the IRS classifies you as a partnership for tax purposes.

If you are the sole owner of an LLC, you may be in for a surprise. The IRS doesn't recognize LLCs owned by one person. Instead, it simply considers you a sole proprietor and the rules for sole proprietorships apply. These are discussed below.

Partnership

If your business is a partnership, you are required to file tax returns by April 15, 2005. You can use form 8736 to obtain a 3-month extension.

Self-Employed/Sole-Proprietor

If you are not using a business entity, your business tax information should be reported on your personal tax return. The due date for filing your personal tax returns is April 15, 2005. You can obtain a four-month extension by filing form 4868.

Summary

Regardless of how your business is organized, the IRS will automatically grant you an extension to file your tax returns. By sending in the appropriate form, you can avoid a mad rush that will inevitably result in missing deductions and overpaying your taxes. Just make sure you pay any taxes you anticipate owing by the appropriate date.

By Richard Chapo

Tax Reform, My Way

We need real tax reform and we need it now. Previous attempts have been made at tax reform, but they have only provided band-aid solutions that have still left us with too many quirks, complication, and read tape. There are several things Congress could do to simply the tax system and benefit the taxpayers and federal budget at the same time.

First, I would institute a simple two-tiered tax on earnings and passive income (interest, dividends, capital gains, etc.) that are not in a tax-sheltered account. They would be treated equally and no distinction would be made between long-term and short-term capital gains. Individuals (whether married or not) who have taxable earnings and passive income of less than $30,000 would pay no federal taxes. Amounts equal to or greater than $30,000 but less than $200,000 would be taxed at 25%. Amounts equal to or greater than $200,000 would be taxed at 30%.

Second, I would get rid of the quarterly estimated tax requirements and associated penalties for everyone except those who are habitually late (after April 15) filing their return and/or paying their taxes. Few things in our tax system are more complicated than trying to figure whether or not you paid enough estimated taxes, whether they were paid on time, and/or the penalty for not doing so. Even the IRS acknowledges how complicated it is to figure out this penalty, as they offer to calculate it for you.

Third, I would eliminate the annual limits on capital losses as well as those special "wash sale" rules, which further restrict the writing off of capital losses. The reporting of capital gains has never been limited and neither should capital losses. "Wash sale" rules restrict the writing off of capital losses for stocks and mutual funds sold at loss but bought back again within 30 days. As I mentioned in a previous writing, these rules can get very complicated, with those for figuring the estimated tax penalty being the only ones that are more difficult to understand.

Fourth, I would keep personal exemptions and child tax credits intact but eliminate all deductions except for charitable contributions and mortgage interest on one's primary dwelling. There would be no standard deduction or Earned Income Tax Credit.

Fifth, I would eliminate the Alternative Minimum Tax (AMT). This is probably the third most complicated item in the tax law. It was designed to make sure the rich pay at least some taxes, but the elimination of most deductions would accomplish this goal now by taking away most of their shelters.

Sixth, I would make some adjustments to inheritance and gift taxes. For the most part, they would not be treated any differently than ordinary income. However, there would be some exceptions. Inheritances and gifts passed from one spouse to another would be exempt from federal taxes. Inheritances of family farms and other legitimate businesses by any family member from another would not be taxable.

These changes would benefit individuals by making the tax system less complicated for everyone and taking a smaller percentage of income from most taxpayers (especially the middle class). The government would benefit from collecting more taxes because more people would be working and receiving higher incomes (as this system would encourage more investment in infrastructure). Also, more people would be encouraged to make more taxable passive income. The current system discourages taxable passive income. In addition, the extremely wealthy would have fewer options for sheltering their income.

By Terry Mitchell

How to Cut Duty Cost and Increase Profit as an Importer

Import duties continue to be significant elements in the cost of international trade. Yet many companies and businesses still pay more duties than the law requires - which impacts adversely on landed cost and ultimately on business profitability. A planned approach to managing customs duty costs would look to eliminate, reduce and delay payment of customs duties.

How to reduce customs duties in your business

There are many ways to reduce customs duties. The amount of duties paid depends on four "whats". Managing the impact of any of these "whats", will improve business profit.

1 What the goods are, (i.e. their nature and characteristics) determines tariff code and therefore the duty rate

2 What the origin of the goods is, (i.e. where dug up, grown, farmed, further manufactured or processed NOT just shipped from) determines whether preferential, standard or additional duties are payable

3 What the structure of the transaction is (i.e. whether sale, leased, loaned, free of charge, under warranty or repair arrangement), determines customs value

4 What happens to the goods once imported (i.e. sold, further manufactured, repaired and returned, stored and re-exported) determines whether various reliefs are available.

How to use a key opportunity in customs valuation planning

A major under utilised approach to reducing duties is to look at the customs valuation. A key provision in both US and EU customs law permits the customs value to be based on any earlier sale of the same goods in a chain of transactions prior to importation. For this reason it is variously described as the "prior sale", "earlier sale" or "chain of sales" opportunity. They all mean the same thing, i.e. lower duty!

How does this work? For example, if goods are sold by a manufacturer in the US for $60 to a US export company which, in turn, sells them to an importer in the EU for $100, duty can be paid on a value of $60, providing certain conditions are met. The savings achieved are the difference between duty on the £100 and the duty on $60. Savings of up to 40% on the duty costs are possible.

What are the benefits? The chief benefit of the approach is to save customs duty by excluding the costs and profits attributable to the non-manufacturing activities undertaken in the country of export from the customs value declared at import in the destination country (US or EU).

The approach also uncouples the value of the imported goods for customs valuation purposes from their inventory value for corporate income tax purposes. That's good because tax and customs values are often in tension. Tax authorities tend to favour a low import value (i.e. more profit to tax), whereas customs favour a higher import value (more import duty to collect.) Using an earlier sale approach, the price paid by the importer is no longer relevant for customs purposes, so that any increase in that price will not cause an increase in the amount of customs duty.

Who can benefit? Any company or business importing goods into the EU or US can benefit from the opportunity providing there has been an earlier sale and the exporter is willing to provide the relevant invoice relating to the earlier sale. Since this involves disclosure of margins by the exporter, the approach is more attractive to international groups of companies where such disclosure is not an issue and to industries where margins are already widely known. However, exporters can still realise the benefits by importing goods into the US and EU on their own account.


By Philip Brigstock-Bates

Home Based Business Tax Deductions

Running a home based business reaps many wonderful tax deductions that other businesses some times may not claim. Unfortunately to many small business owners end up paying the government taxes every year because they are unaware or several small business deductions that are available.

Most of the time any expenses that are related to your business can be added as a deduction on your taxes. If you do not pay taxes through out the year, deductions can help you from paying a large amount of taxes each year and can also adjust earned income. Try to avoid paying large amounts of taxes or owning any money by keeping track of simple things!

Each business is a bit different so be sure to mention these ideas to your tax advisor or accountant to see if your business can qualify for these deductions.

1- If you join any business or purchase into any franchise, the expenses such as kits, or franchise fees may be claimed as a deductions.

2- Business Supplies. Be sure to save all receipts for any supplies you purchase for your business use. Computer paper, business cards, pens, catalogs, or any items you purchase and use for your business.

3- Advertising- Most advertising can be claimed on your taxes. Keep all receipts for any newspaper ad's you may run, or any advertising you do online. Advertising is a business expense and in most cases can be written off.

4- Items Given Away- Keep a list of any items you may give away, and the costs of these items. Most freebies may also be written off.

5- Phone bills and internet access- If you have a phone line for business use or have the internet in your home or office for business use, save all receipts for each bill paid. These items are business expenses and may also be written off.

6- An in home office- If you have an office in your home, make sure to let your tax advisor know. Using a room in your home as an office can also be added on taxes.

7- Long distance calls- If you make any long distance calls that are related to your business, make sure you keep all phone bills showing the calls and the amounts charged. If these calls are related to your work, the cost of the calls may also be written off in most cases.

8- Returned Checks and Bank Fees. If you incur and bounced checks from customers and can not collect on them, those amounts may be deducted, along with any fees you were charged from your bank. Be sure to keep the returned check, the letter from your bank and your bank statement to show the fee you were charged.

9- Postage- All postage costs paid by you or shipping fees may be claimed. Keep receipts for all shipping supplies, and postage.

10- Computers- If you purchase a new computer for business use, the cost of the computer may be claimed. You may also claim depreciation for 3 years after the computer was purchased.

About The Author

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By Tara Grant