Blog - The Official Blog of Gerri Lazarre, CPA, MST with TriMerge Consulting Group, PA - Certified Public Accountants and Consulants
Hello and welcome to Gerri Lazarre's Tax and Accounting Blog, sponsored by TriMerge Consulting Group, PA, a Certified Public Accounting and Consulting Firm. In this blog, it is my goal to educate the world on accounting, financial, business, real estate and tax matters. We will be featuring advice and articles that our of concern to you. I am a licenced CPA with a Masters of Science in Taxation and realtor .
Deep down inside each of us is an entrepreurial spirit. Outside of having the notion that you want to be your own boss, and selecting what product or service to consier, there are many other important decisions that need to be made such as business formation. Understanding and deciding which business structure could be right for your business is a key consideration. There are many different legal structures for your business; we have provided some key points to consider when deciding which business formation are right for you.
There are many different legal forms for start up and existing business entities. Each business entity is organized differently and may have local, state and federal requirements to adhere to depending on the structure. For example, in the state of Florida S corporations are generally not required to file a Florida corporate income tax return if they do not have federal taxable income, while in the state of Oregon, S corporations doing business in the state or receiving income from Oregon are required to file a state tax return. Therefore deciding which legal entity to create is important in order to understand the legal, local, state and federal requirements of the entity selected and the many compliance requirements. Some of the basic compliance requirements deal with taxes, licenses and permits which can translate into additional fees and cost to the owner etc. There are many business structure forms; however the most widely utilized structures are as follows:
Partnerships which can be general or limited liability and joint ventures
Regular corporations (referred to as C corporations)
Limited liability company (LLC)
There are many considerations in making the choice of the entity for your business. Two of the key considerations in deciding the entity of choice are business and tax related. Some other considerations deal with state laws, protection of personal assets from liabilities of the business, the need for additional capital and transfer of ownership.
The business considerations that are important to the decision of selecting which business to form are vast, however the decision is more times specific to each business owner’s objectives and the industry. There are many tax considerations; however we will touch on some of the most important tax points to consider for each business form.
A C corporation is a separate taxpaying entity. It has its own tax rate schedule. The shareholders of a C corporation also pay tax on the dividend distribution from the corporation in effect there is a double taxation of earnings at corporate level and again at shareholder level. The C corporation structure may be the best formation for raising capital and initial public offering, which is commonly known as an IPO.
S Corporation is a regular corporation with advantage of limited liability but without the disadvantage of double taxation of C Corporation earnings. An S corporation’s items of income, gain losses deduction and credits pass through to its stockholders to be reported on their own income tax returns.
A partnership is an entity that is separate from its individual partners. In a General partnership partners are jointly and severally liable for the partnership debt. In a limited partnership there are general partners and limited partner. The limited partner is not personally liable for partnership debts beyond the capital contribution. The partnership itself is not taxable entity but it computes and reports its income, expenses, gains and losses and each partner reports pro rata share of those items on his or her income taxes.
An LLC is generally formed under various state laws of limited liability corporations. Generally the members (partners) of LLC can make an election to be treated as a partnership for tax purposes. LLC’s can in some situation provide certain advantages over the corporate entity.
A Sole Proprietorship is the simplest form of business. It is not separate from the owner of the business. A sole proprietor has unlimited personal liability of the business debt and claims. Income and expenses on the business are reported on the personal income tax return on Schedule C of the owner.
In recent year’s use of an S Corporation as an entity has become the favorite entity formation of small businesses. It must be mentioned that there are certain restrictions as to which corporation can make election to be treated as an S corporation. A main reason for its popularity is limited liability protection without double taxation.
Short Sale Explained
by Gerri Lazarre, Licensed Realtor and Certified Distressed Property Expert (CDPE) · April 28th, 2009
A "short sale" is selling the home for less than the mortgage balance with the objective of getting the lender to forgive the unpaid balance. In the past it was rare that a bank or lender would accept a short sale however due to overwhelming market changes lenders have become much more negotiable when it comes to these transactions. Recent changes in policy within many organizations have made the chances of getting a short sale approved even higher. With the explosion of failed mortgage loans and the effects of a tightening mortgage credit, we will undoubtedly soon see more cases involving short sales
Short Sale Explained
A homeowner is short when the borrower owes an amount on his property that when combined with closing costs and commission is higher than the current market value. A short sale occurs when a negotiation is entered into with the homeowner’s mortgage company(ies) to accept less than the full balance of the loan at closing. A buyer closes on the property and the property is “sold short’.
A reason for debtors to consider a "short sale" instead of a foreclosure is to try to protect their credit history. A short sale is a way to avoid foreclosure. A foreclosure is a credit item that lasts forever. In rare cases, lenders also pursue deficiency judgment against borrowers and attempt to collect the amount that was short, however this may be changing. In the State of Florida, a lender has up to 5 years to issue a deficiency judgment, up until now few institutional mortgage lenders were pursuing deficiencies in Florida. If the lender seeks a deficiency judgment in the State of Georgia, the lender must file for a deficiency within thirty (30) days of the foreclosure sale. Therefore you can see the rules differ depending on the state. Beyond that, there are financial consequences of a short sale.
Short Sale – Financial Consequences
The Mortgage Forgiveness Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence. Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, qualifies for the relief. The provision applies to debt forgiven in calendar years 2007 through 2012. Up to $2 million of forgiven debt is eligible for this exclusion. The exclusion does not apply if the discharge is due to services performed for the lender or any other reason not directly related to a decline in the home’s value or the taxpayer’s financial condition.
If the borrow does not qualify for the above exclusions, the IRS defines the amount borrowed as ‘short’ as having been ‘cancelled’. This is commonly referred to as a cancellation of debt, which is when the borrowed money from a commercial lender and the lender later cancels or forgives the debt. It is required for the lender to also issue the seller a Form 1099-C, Cancellation of Debt for the amount the seller is required to claim as income for tax purposes. When the borrower originally borrowed the money, it was not required to include the loan proceeds in income because of the obligation to repay the lender. However, when the obligation is subsequently forgiven, the amount previously received as loan proceeds is normally reportable as income because there is no longer an obligation to repay the lender.
The Short Sale Process
The first phase of the short sale process is preparation. The second phase deals with advertising the property in short sale. The third phase is accepting an offer from an approved buyer. The fourth phase deals with submitting your proposal to the lender(s). The final stage of the short sale process deals with negotiation and closing.
Of course this sounds easy enough, however this is an involved process that takes time, patience, good communication skills, organization on your part and professionalism. By utilizing the services of a CDPE (Certified Distressed Property Expert) as your licensed realtor, the process of negotiating a short sale will be much easier.
When starting a new business, there are many important decisions to make and many rules
and procedures that must be addressed, it involves making key financial decisions and
completing a series of legal requirements. While there is no single source for all filing
requirements, the following steps have been developed to assist you in starting your business
and to help you plan, prepare, and manage your business.
-Name your business, determine an appropriate company name, location and or
jurisdiction and contact information. A fictitious name filing may be required in your
-Apply for an Employer Identification Number (EIN).
-Select a business structure? Are you a sole proprietorship, corporation or S
corporation (by election), a limited or general partnership, a limited liability company
(LLC) or limited liability partnership (LLP), unincorporated association or trust?
-Determine the name(s) and title for each officer, director, member or partner.
-If a corporation, obtain the Articles of Incorporation, which is also referred to as the
Certificate of Incorporation, which is the primary rules governing the management of a
corporation in the United States. This will also require describing the number of shares
the corporation is authorized to issued, the names of the members of the board of
directors and the registered agent.
-Obtain federal, state and/or local business and professional licenses and permits for
your business; this may be dependent on your industry or profession.
-Obtained business insurance, some professional licenses require certain insurance
-Assemble your management team of professionals either through an employment,
contractor, consulting, investor or equity owner relationship, for example (accountant,
attorney, sales and or business development, human resource etc.).
-Obtain a D&B DUNS Number; the federal government requires organizations to
provide a DUNS number for grants or contracts. Dun and Bradstreet (D&B) is a
company that provides business information for credit, marketing, and purchasing
decisions. It’s “data universal numbering system,” known as DUNS, issues unique nine
(9)-digit numbers that are used by businesses and the federal government to keep
track of more than 70 million businesses world-wide.
-Determine the company’s National American Industry Classification (NAICS) Code.
-Pursue certification for federal government set asides where applicable, this may be
some of the following: Women Owned Business classification, HUB-Zone
classification, Service-Disabled or Veteran-Owned classification or the 8a Certification
with the Small Business Administration (SBA).
-Research the Simplified Acquisitions Basics for the governmental agency you plan to
do business with. Agencies under Federal Acquisitions Regulation (FAR) typically
purchase products and services in three ways: through sealed bids, negotiation or
simplified acquisitions. The procurement process for a simplified acquisition is
streamlined and many federal contracts are reserved exclusively for smaller firms and
range between $2,500 to $100,000.
-Register with the Division of Corporations in the state where the company is organized
and where it will be doing business. This may be dependent on the business structure.
-Register as a vendor with the state procurement department where you will be doing
business or other departments and agencies within the state.
Local & Other
-Register as a vendor with city, county and district procurement departments.
-Register as a vendor with corporate and nonprofit agencies to do business through
their procurement departments, this may include corporate companies such as Office
Depot, Microsoft, Mobile or Wal-Mart as examples and hospitals or universities.
-Register with an affiliated regional council of the National Minority Supplier
Development Council, Inc. .
Business Plan, Proposal or Profile: .
Business Plan: It should describe the fundamentals of your business idea and provide
financial data to show that you will make money. Beyond that, the content of your
business plan depends on how you intend to use it. Depending on whether you're
trying to attract investors or are creating a blueprint for your own use, a business plan
can take somewhat different forms. A business plan is a blueprint of every aspect of
your business and includes some of the following:
1. Executive Summary
2. Company Summary
3. Products and/or Services
4. Market Analysis Summary
5. Strategy and Implementation Summary
6. Management Summary
7. Business and Financial Assumptions (Benchmark)
Business Proposal: This is not a business plan, but can take on many forms. The goal
of the business proposal is to answer the needs of the customer or prospective
customer, it is a written offer from a seller to a prospective buyer, and is often a key
step in the complex sales process when a buyer considers more than price in a
Business Profile: A business or company profile is a marketing document designed to
catch the attention of and inform potential buyers or investors about your goods and
-Create your team of professionals which should include legal, accounting and other consulting services.
-Raising finance through grants, commercial or government backed loans, venture
capitalist and or owner capital contributions (i.e. cash, loan, equipment, etc.).
-Establish business banking for business identity and to keep business finances
-Create an accounting system; setting up the accounting will help to understand the
financials of running the business.
-Create management and financial reports for internal and external readers which may
include some of the following: Cash Flow Analysis, Revenue and Expense Forecast
and Projections, Net Worth Analysis, Debt Management/Structuring.
-Obtaining an audit, review or compilation by a Certified Public Accountant (CPA),
which may be required to meet lending or debt covenants or license and certification
-Understand state and federal tax rules, regulations and responsibilities of the
business; this may include sales tax, tax certificate, workers’ compensation,
unemployment, annual filing requirements, tax liabilities and other tax preparation and
The popular trend of issuing stock options as a form of executive and employee compensation during the dot-com era presented many tough questions and choices for the average employee; an unfamiliar territory for most. What are stock options? Are there advantages and disadvantages of exercising stock options? How does this affect my tax liability? The new trend of offering stock options by employers coupled with unanswered questions confused many individuals. Stock options almost seemed, as foreign as the language of French. A stock option, a form of stock based compensation, is defined as a right to buy or sell a specific security or commodity at a stated price within a specified time frame. Huh? With a definition so puzzling, it is easy to understand how even today, most people compare learning about stock options like learning a new language, which requires wrestling with unfamiliar terms. Like learning the universal language of France, there are a few concepts that one must grasp to start understanding the common language and culture shared by some European countries, France and other French speaking countries. This article is to give you the basic understanding of stock options and the financial planning tools necessary to create a wealth building strategy when considering employee stock options as an investment alternative.
The National Center for Employee Ownership (NCEO) estimates that employees control at least ten percent of total U.S. corporate equity, up from about 2% just a decade ago, and that employee stock ownership plans account for at least $500 billion. As of March 2005, the NCEO concluded that it is reasonable to estimate that 10 million employees held options in 2003, with a margin of error of two million or so in either direction. As employees increase their ownership stake in company stock, employee stock options can become a significant portion of their investment portfolio. Therefore, understanding the basics of stock options is critical.
What is a stock option?
In plain, English, a stock option allows the owner, usually the employee, the option to exercise the right to purchase a share of stock at a certain price by a certain expiration date in the future. The company determines the exercise “vesting” period, which is the maximum amount of time during which the options can be exercised to purchase a share or shares of the underlying security. Ten years is usually the normal vesting period, however, the vesting period can range from one to ten years depending on the employer. A recent survey by consultants, Watson Wyatt Worldwide, noted that most options fully vest after the third or fourth year. During this time period, the employee may decide to exercise their options or to allow them to expire. Usually the price of the option is set to the fair market value (FMV) of the stock at the time the option was sold. If the stock appreciates in value, the option becomes more valuable, while the reverse occurs if the stock decreases in value.
There are many plan arrangements available to employers, most broad-based plan arrangements fall under Nonqualified Options or Incentive Stock Options (ISOs), also known as qualified stock options because they qualify to receive special tax treatment under the Internal Revenue Code. However, the strategy taken by the employee and the plan arrangements offered by the employer will have a significant impact to the employee. Nonqualified stock options are the most popular incentive compensation plans for the majority of employees while ISOs are more suited for executives. Under a Nonqualified stock option plan, there is no tax when the option is granted. However, the employee will be required to pay ordinary tax on the difference between the grant price and the stock’s FMV when the shares are exercised (“purchased”). The employee is still required to pay ordinary tax on the spread even if the stock decreases in value. Many employees are haste to cash their stock options; however, this may not always be the most favorable strategy. There will be a significant tax burden to the employee depending on the amount of shares exercised and the employee’s marginal and effective income tax rate. There are three basic ways to exercise stock options: pay cash, use existing shares or use a broker to finance the option. This is a burden that most are unfamiliar with and/or are not prepared for. Consider consulting with an advisor prior to making hastily decisions. Unlike Nonqualified stock options, ISOs do not require a tax burden on the difference between the grant price and the stock’s FMV when the shares are exercised. The employee is able to defer taxation until the shares bought are actually sold, which is an advantage over Nonqualified stock options. Highly compensated employees benefit more than low paid employees, since highly compensated employees are more likely able to have liquid cash available to buy the shares at the exercise price and hold the shares during the holding period, which is the time between the exercise date and sales date. This strategy may allow for long-term capital gains treatment, which can result in a 20% tax savings over ordinary rates if the holding period requirements are met. However, one of the disadvantages to ISOs is that the difference at exercise is considered a preference item for purposes of calculating the Alternative Minimum Tax (AMT). The AMT is an additional tax liability; however it may be avoided if a disqualifying disposition occurs.
Most companies reward employees by issuing stock options, which allow employees to share ownership in the company and to align the interests of the employees with those of the company. Depending on which employee stock option plan is employed by the employer, the reward may also carry a significant burden. Therefore, it is important for employees to educate themselves and consult with a professional to assist in navigating through the language of stock options and the effects of this popular phenomenon on their road to developing their wealth building strategies.
Individuals & Businesses Planning Under Changing Tax Laws
The new tax law changes passed by Congress in 2004 provided Federal tax relief to individuals and businesses. The new laws extend some popular tax benefits for families and extend several business provisions that had expired or were due to expire. The laws also creatednewtax breaks for both individuals and businesses. Many of the tax law changes are complex while some will provide only temporary relief; this provides many tax planning opportunities for you, your family and your business.
In 2004 two important changes were made to the tax law as we know it. The Working Families Tax Relief Act of 2004 (WFRTA ’04) and the American Jobs Creation Act of 2004 (AJCA ’04). Unlike most recent tax legislation, the new law is “revenue neutral” in that the new and expanded tax breaks are equally offset by revenue raisers and loophole closers.
There are literally hundreds of changes. Many are indecipherable and may not apply to your individual or business situation. However, a number of the changes can make a significant impact on you and your company. The following are a few of the legislative changes that may have an effect on individuals and small and medium sized businesses in 2004 and beyond.
New itemized deduction for state and local general sales taxes. For the tax years beginning in 2004 and 2005, the New State and Local Sales Tax Deduction allows individuals the option of claiming an itemized deduction for either general state and local sales taxes or state income taxes, however both cannot be taken. The state and local sales tax deduction allows you to choose to deduct actual sales tax amounts or instead deduct an amount using the Optional State Sales Tax Tables; you can add to the table amount any state and local general sales taxes you paid on motor vehicles, boats and any other items specified in the rules. This change is intended to put those who live in jurisdictions with no or low personal income taxes, such as the State of Florida, on an equal playing field with those who are able to deduct state and local incomes taxes. This deduction is only available for the tax years beginning in 2004 and will sunset after tax year 2005.
$1,000 Per Child Tax Credit Retained. The Child Tax Credit allowed in 2004 is $1,000 for each qualifying child under the age of 17. The child tax credit was scheduled to decline in tax years 2005-2008 to $700 and then subsequently increases starting in 2009 and then reverts to $500 in 2011. The new tax law changes in WFTRA ’04 addresses the imperfections of the old rules by simply increasing the credit to $1,000 for the years 2005 through 2010. However, sunset provisions written into the law will cause the tax credit to revert back to $500 in 2010, unless a new law is implemented. In addition, the new law standardized the meaning of “child”. A more uniform rule is applied to the meaning of child for the child tax credit, earned income credit, dependency exemption and for head of household filing status.
Tougher rules for charitable donations of autos. If you plan to make a charitable contribution of property (other than cash) in 2004 read closely. The IRS has implemented more stringent rules to substantiate the property’s value. For starters, taxpayers will no longer be able to use the “Blue Book” value when donating a vehicle (including boats and airplanes). The deduction will be limited to the gross proceeds received by the charitable organization when they sell the property. The taxpayer will also be required to attach a statement from the organization identifying the property and sale or their deduction will be disallowed. For non-cash contributions over $5,000 a qualified appraisal must obtained and if the contribution exceeds $500,000 the appraisal must be attached to the return.
Patents, copyrights and other intellectual property contribution deductions are also limited. Under pre-AJCA ’04, the full fair market value was allowed. To mitigate abusive valuation practices that provided inflated deductions for taxpayers, AJCA ’04 now allows the taxpayer to only deduct its cost and any income derived by the charitable organization over 10 years.
Marriage penalty relief extension has been granted under WFTRA ’04. Married couples can enjoy a full marriage penalty relief in the standard deduction through 2010. In addition, relief in the 15% tax bracket is extended until 2010. WFTRA ’04 accelerated the benefits.
Expanded 10% bracket is extended until 2010. The new law allows more income to be taxed at a rate of 10% than at the 15% or higher tax rates. Thereby allowing individuals to reduce their tax liability. The 10% income-tax bracket is in effect until 2007, unless new tax law changes are made.
Alternative Minimum Tax (AMT) being addressed in the new tax law will provide some relief by extending the higher exemption amounts. Congress allowed for one more year for millions of taxpayers to start addressing the problem of eventually paying the AMT. The higher exemption amount of $29,000 for married persons filing separate returns, $40,250 for individuals and $58,000 for married individuals filing a joint return and surviving spouses has been extended through 2005.
The Educators Expense Deduction has been extended for tax years beginning during 2004 and 2005 for eligible teachers, counselors, principles and other educators. This deduction allows these individuals to deduct up to $250 in qualified expenses for books, supplies, computer equipment and other supplies bought and used in the classroom whether or not the educator itemized their deductions or utilized the standard deduction.
Extension of Current Section 179 Deduction Rules. Congress raised the threshold for small business expensing from $25,000 to $100,000 in 2001. Congress has extended the Section 179 expensing first-year write-off for business equipment purchases for two more years – through tax years beginning 2007. For tax years beginning in 2008 and beyond, the maximum deduction is scheduled to fall back to only $25,000 unless Congress takes further action.
So what does this mean to you? The additional extension allows businesses to expense immediately up to $102,000 of qualifying property purchased in 2004. The extension of the Section 179 deduction rules will provide businesses with a maximum tax savings of more than $35,000! Be aware however, that the deduction may be limited by the total cost of property placed in service and your taxable income during the year of the Section 179 election. You may also be subject to the recapture rules if you dispose of the property or stop using it for business. While there are may factors that must be considered when making decisions to acquire property, accelerated tax benefits may allow you to purchase the property you need at reduced after-tax costs.
Limited Expensing Write-off for Heavy SUVs. Sport Utility Vehicles (“SUVs”) gained popularity a few years ago from the ability to expense up to $100,000 of the purchase price of heavy SUVs (over 6,000 pounds) because they are not subject to the "luxury auto" depreciation dollar caps and lease-income-inclusion-amount rules. Under the rules that applied before the AJCA ‘04, this meant that the entire cost of a heavy SUV used 100% for business could be written off under the Section 179 expensing rules. Congress has decided to tighten the SUV loophole for vehicles placed in service after October 22, 2004 by allowing only $25,000 of the cost of a heavy SUV to be expensed immediately.
Tightening however does not mean that the loophole is closed entirely. Heavy SUVs remain to be treated favorably under the tax laws given that the rules limiting the amount of annual depreciation that can be deducted on passenger automobiles do not apply to heavy SUVs. The idea of buying a new heavy SUV may still be attractive as there are opportunities available to enjoy substantial tax savings.
New Rules for Start-up and Organizational Expenditures. If you have recently started a business, or in the process of starting one now, you should be aware that the businesses initial expenses can make a big difference in your tax bill. Previously taxpayers could elect to amortize business start-up and organizational expenditures (expenses incurred before the operation is up and running) over 60 months. Under the new law, taxpayers can immediately deduct up to $5,000 of start-up costs and up to $5,000 of organizational expenditures (incurred after October 22, 2004) in the tax year in which the business begins. However, each $5,000 allowance is reduced by the amount of cumulative costs in excess of $50,000. Startup and organizational expenditures that are not deductible in the year the business begins must be capitalized and amortized over 15 years on a straight-line basis. This change will enable some small businesses to deduct their start-up expenditures in a single year but for larger businesses it will stretch out the period for recovering such expenditures.
Big Changes for S Corporations. The AJCA ’04 has made it easier for companies to qualify and operate as an S Corporation.
Number of Shareholders. The new law allows family members to be treated as one shareholder for purposes of determining the number of shareholders of an S corporation. Even better, the new law increases the maximum allowable number of shareholders from the current 75 to 100. These changes are effective for tax years beginning in 2005 and beyond.
Suspended Losses after Divorce. The new law allows S corporation losses that were suspended due to basis limitations to be transferred (along with the related S corporation shares) to a spouse or former spouse in a divorce. This change is effective for transfers after 2004.
New limit on company deductions for entertainment, etc., provided to officers and directors. For expenses incurred after October 22, 2004, AJCA ‘04 limits a company's trade or business deduction for costs of entertainment, amusement, or recreation-related goods, services or facilities it provides to officers, directors, and 10%-or-more owners. The costs are deductible only to the extent that they do not exceed the amount of expenses treated by the company as compensation income to the recipient as a result of receiving those goods, services, or facilities. Under prior law an employer's deduction for providing an entertainment or recreation-type perks to employees or independent contractors was not limited to the amount properly charged to the employees or independent contractors as compensation income for the perk, but was allowed for the entire cost of providing the perk.
The recent tax legislation contains literally hundreds and hundreds of changes. Most of the changes will not affect the average person. However, a good number of the changes may affect you, your family or your business. The information presented above highlights some of the changes to our new tax law and the effects it will have on your situation. It is no way a complete guide to the ever-changing rules and regulations. To benefit fully, you may need to revise and rethink your current tax planning strategy and act quickly to seize opportunities before they expire and sunset into the abyss.
The complexity of the tax law amendments in recent years has made tax planning more like a jig saw puzzle. As the tax law, the economy and individual finances become more complex, getting expert guidance to help you sift through the numerous tax saving opportunities to minimize your tax liability will be vital.
Please feel free to contact us for more information about the issues discussed or other tax planner matters affecting you, your family and your business.
Freelance Professionals - Tax Strategies for Creative Professionals
From the early morning executive board meeting to attending the current months networking event or social gathering with your local Chamber, many professionals are finding the time to start their own businesses and leaping into the world of entrepreneurialship by way of freelance work. Freelance professionals are moonlighting and exploring their creative talents as writers, photographers, publicist, real estate advisors, consultants and other crafty professions with a creative twist, which can result in juggling self-employment on a part time basis with full time employment.
This is exciting and fabulous news, many are harnessing their entrepreneurial spirit and embracing self employment by taking some risk, control, and pushing the limits of what’s known and understood. However, this new understanding means understanding your business composition and developing some basic tax strategies to benefit this structure. Most freelance professionals are operating independently as sole proprietors. A sole proprietor is synonymous with “self-employed,” “independent contractor,” or “freelancer”. The U.S. Bureau of the Census, 1997 Economic Census, estimates that individual proprietorships account for approximately 73% of all types of legal entities organized in the United States, this is roughly 15 million. The popularity of the sole proprietorship formation makes it one of the most common and widely used forms of business structure and is defined as any unincorporated business with one single owner. Assumingly, the role of a self-employed professional is quite possibly one of the best tax strategies available today. However, there are special circumstances that apply to freelance professionals when preparing their tax return; this article will examine some basic tax strategies and benefits of being self-employed.
Innovative tax planning is key to developing a plan to combat taxes. Most freelance or semi self-employed professionals can lower their tax burden through proper planning. Some advance planning can make a measurable difference to minimize your tax liability and maximize the profit margins of your new undertaking. The time to consider tax savings strategies for your sole proprietorship is early on. As a freelancer, you may need to consider planning for federal income taxes because your new venture may become extremely profitable in the first year and if your income tax withholdings deducted from your paycheck with your current employer is not sufficient, you may be subjected to penalties. More than likely, the income generated from freelance work is not subject to withholdings, therefore you may have to make estimated tax payments. The law provides several safe harbors for determining the minimum estimated tax that must be paid to avoid penalties; however, your tax planning strategy should begin with a projection of your estimated income, deductions and tax liability for the current and previous year. Other strategies and measures that can be beneficial through early tax planning deal with shifting income and deductions into the most advantageous year. Deferring income and accelerating deductions from future years is a tried-and-true-year end strategy for reducing current year taxable income that never gets old. Most sole proprietors use the cash basis to determine their accounting method – income reported when received and deducted when paid. In essence, income generated from freelance work can be accelerated into the current year or deferred into the subsequent year by controlling the receipt of income and payment of deductions after comparing computations to determine and evaluate the net-after tax result of these actions.
Organization and record keeping are key ingredients toward building a successful strategy. The first step in organization is to separate your freelance income from other types of income. The second step is to pay close attention to the various types of business related expenses you incur while performing freelance work. It is highly recommended that you start tracking your business related income and expenses using one of the popular software programs or simply using a spreadsheet program such as Microsoft Excel or choosing whatever other method you’re comfortable with. Most clients of freelance professionals will provide them with Form 1099-MISC to report payments made in the previous year in January or February of the current year, this form is similar to the reporting of income by your employer when using a W-2. The IRS will also receive a copy of any information reported to you on Form 1099-MISC; therefore, it is advantageous to report all income in order to prevent receiving a computer-generated audit notice from the IRS.
As a freelance professional, you have essentially created a business, therefore utilizing the Internal Revenue Code to help maximize your tax savings is a maneuver not to be overlooked. In 2003, President, George W. Bush signed the Jobs & Growth Tax Relief Reconciliation Act of 2003 encompassing growth incentives for businesses. The Act increased the section 179 expensing limit to $100,000 for property placed in service in taxable years beginning in 2003, 2004 and 2005. The section 179 expensing deduction was subsequently increased to $105,000 for 2005 by the American Job Creations Act of 2004 and has been extended until 2007 and indexed to inflation. A new business with relatively small equipment purchases could potentially deduct all or part of the cost of certain qualifying property in the year the asset is placed in service. For a freelance professional on the go, this could potentially mean the deduction of equipment such as computers and office equipment, various software programs, printers, cellular phones, palm pilots and more. Other business deductions commonly deductible yet overlooked under IRC section 62 relate to advertising and promotion, dues and subscriptions, license and permits, business meals and entertainment with certain limitations, travel and certain auto expense. Deductions lower your taxable income while credits lower your taxes, therefore, discovering how deductions and credits affect your sole proprietorship is highly recommended. Consequently, many self-employed professionals typically miss deductions and credits as a result of navigating through unfamiliar Internal Revenue Code territory that are often reserved for the professionals. Therefore, consider consulting with a tax advisor to assist in navigating through the Internal Revenue Code before you start planning your tax year because there is no substitute for professional guidance.
Not to be overlooked are special taxes you get to pay for being self-employed, such as self employment tax, which can add up quickly. But, depending on your tax strategy, many tax issues can be overcome. Most start-ups develop out of a desire to pursue creative passions, gain creative flexibility and control or to simply increase income streams without much risk, however not considering a tax strategy can carry a significant burden in the pursuit of entrepreneurialism. Therefore, including a tax strategy that encompasses ingenious and innovative planning solutions, organizational readiness along with the ability to extract every silver of tax benefits from the most current tax laws and other new developments will maximize savings and minimize your taxes.
Disclaimer under IRS Circular 230: Unless expressly stated otherwise in this transmission, nothing contained in this message is intended or written to be used, nor may it be relied upon or used, (1) by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer under the Internal Revenue Code of 1986, as amended and/or (2) by any person to support the promotion or marketing of or to recommend any Federal tax transaction(s) or matter(s) addressed in this message.