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Estimated Taxes for The Ant & The Grasshopper

Every year I see & hear horror stories about estimated tax payment gone wrong. I’m not sure which is worse, the person who didn’t have any idea they needed to make tax payments for both income and self-employment taxes or the person who set aside the money then used it as a down payment on a house, boat or to buy shares in some shady investment scheme.

The problem with estimated payments is not only are they confusing, but the “right” way to make estimated payments depends entirely on your personality and your financial situation.

For instance, if you’re hit with a whopper of a tax bill come April 15th, will you be able to blithely write out a check or will you be in a frozen panic? Does it gall you to get a big refund knowing the US Treasury has had the free use of your money throughout the year? Or is that new sports car irresistible, knowing there’s stash of cash in your savings account, never mind that it’s for your upcoming tax bill?

Tax Implications of those E-Bay Auctions

The IRS added a new article to its website, to help those of us who emptied out the garage or storeroom by selling unwanted items on E-Bay or other online auctions. The article outlines the required tax reporting on those sales.

Generally, if you sold personal items for less than you actually paid for it, then you don't have to do anything. :)

But if you sold personal items that appreciated in value have to report any gain. If it's art, antiques or other collectibles you pay the 28% tax rate. Otherwise you'll pay the normal capital gains rates.

New Way to Make IRA Contributions

Wouldn't it be great if you could make your tax refund right into your IRA for your annual contribution?

Well, now you can. The IRS now allows you to split your refund into several accounts including an existing IRA account.

To do this you need to file Form 8888 with your return. There are a couple of tricky caveats so be sure to read all the instructions.

For instance the IRA account must already be established. And you must let your financial institution know that the deposit is coming and which year you want it applied to. If you don't designate the deposit as a 2006 contribution it could be treated as a 2007 contribution.

The Home Office Deduction: What happens when you sell your home?

The home office deduction is one of those deductions people often tout as an advantage of having your own business. But one of the disadvantages of taking the home office deduction people don't really talk about is its effects when you finally sell your house.

Say you work from your home and over the course of several years you took the home office deduction including $5,000 in depreciation expense on the portion of the house used in business. When you sell that home, the depreciation you took in prior years is not excludable. In fact, you have taxable gain of $5,000. And not a long-term capital gain. It's a called Unrecaptured Section 1250 Gain. You report this on Schedule D, Line 19. This amount then gets transferred to the utterly confusing Schedule D Tax Worksheet.

If you can wade through the worksheet, you'll find that this gain is taxed at a flat 25%. This means that the depreciation deduction you take for your home office today is really just a deferral of taxes to future years.

Add to this the fact that the home office deduction is a red flag for IRS audits and your mortgage interest and property taxes are already deductible. That's why if there's any question as to your elibigility for taking the deduction, don't. When you get down to really crunching the numbers, the actual monetary benefit is rarely outweighs the hassle.

For more information on this see IRS Publications 523, Selling your Home and 587, Business Use of Your Home along with the Instructions for Schedule D.

Figuring Equivalent Billing Rates: W-2 vs. Corp-to-Corp

I often see questions posted asking what is the equivalent corp-to-corp rate for a given hourly rate paid to an employee. I think a better question is what rate will the market bear. But be that as it may, there are several issues you need to consider if you're trying to come up with an equivalent for a starting point.

The most important point is usually what benefits do you have as an employee that you will have to make for when you switch to a corporation.

If you are transitioning from an employee of a large corporation to owning your own business you might be surprised by the employee benefits you probably take for granted. For example as an employee you probably get around 10 days off per year for holidays. You also probably get two weeks PTO for sick days and vacation. Both of those are out when you go to work for yourself. You'll only get paid for the hours you can actually bill your clients. On the other hand, you will get paid for each hour you actually work, where as if you're getting a salary you just get a lump sum no matter how much overtime you work.

Reclassifying an Independent Contractor to an Employee

If you're an unhappy independent contractor, should you try to get reclassified as an employee? How would you go about such at thing??

The IRS has very specific rules about who is an independent contractor and who is an employee. You can find out more about there rules in IRS Publication 1779, Independent Contractor or Employee and Publication 15A, Employer's Supplemental Tax Guide.

Basically, an independent contractor can be told what to do, but not how to do it. Also, an independent contractor can't quit or be fired until the job s/he is hired for is complete. If an independent contractor is working side by side with employees and treated as an employee s/he is usually considered to an employee from the IRS's perspective. A contract with specific language indicating you are an independent contractor may give some cover to the hiring firm regarding your relationship.

The Tele-Teddy Tax Refund Coming to 2006 Tax Returns

Most people probably think that once a new tax was enacted it will never be repealed. Well, here is the exception: The Federal Telephone Excise Tax. This tax was enacted by Teddy Roosevelt way back in 1898 to pay for the Spanish American War. It was based on the how long you talked on the phone and how far away you were geographically from the person at the other end of the line. I like to think of it as the Tele-Teddy Tax!

The Federal Telephone Excise Tax stopped appearing on your phone bill as of August 1, 2006 after the federal government lost a series of court cases. And now the IRS is going to refund the taxes you paid with your phone bill between February 2003 and August 2006! As everything with the IRS, the devil is in the details.

There are two ways you can request a refund: a safe harbor amount or the actual amount.

Why Are You Paying More to Outsource IRS Collection Efforts?

There have been many news reports lately regarding the IRS’s new program to outsource delinquent tax collections to private collections agencies or PCAs including this report in the New York Times.

According to the IRS it will be paying PCAs 22¢ to 24¢ on the dollar to collect funds that are due to the federal government which is far more than the 3¢ to 7¢ on the dollar it would cost if IRS agents did the collecting.

Why is the IRS outsourcing collections if it can do it more efficiently? Congress has refused to authorize the hiring of more IRS agents to assist with the collection efforts.

Yes, I had to do a double take on this too. The nation debt is over $8.5 trillion and the federal government is running a deficit of over $300 billion dollars a year. Meanwhile the tax gap for 2001, the amount citizens actually owe vs. the amount they paid, is $290 billion after the efforts already made by the IRS to collect amounts due.

Given these staggering amounts, it seems to me a no-brainer for Congress to fund internal collection efforts. The annual deficit could be brought to near zero if Congress just gave the IRS the tools it needs to collect what is already due. Instead taxpayers, you and me, will foot the bill for the more expensive private collection agencies.

It just boggles the mind.

Wearing the Wrong Shoes to Tax Court Can Cost You

The TaxProf has blogged a Tax Court case that made me groan. And probably any tax professional worth their salt.

The story is of a welder in West Virgina who was "assertive" when claiming unreimbursed employee expenses on Form 2106. Among other things he claimed $600 in unidentified clothing and gloves. In order for uniforms to be decutible they cannot be suitable for general or personal wear. Painter's pants, for example, are specifically listed in IRS publications as not deductible.

Knowing this, what shoes would you wear to court??

Well, our hapless defendent showed up in court wearing his Rocky Wolverine boots, which were included in the $600 deduction. By wearing them to court, he made the judge's ruling a no-brainer. If he could wear them to court they were suitable for personal use and therefore not dedubtible.

Now I don't know if he had a tax professional prepare his return (I would hope not given the further details in the court, edit version available here). But surely our welder hired someone to represent him in Tax Court? Shouldn't that person have advised him of the actual rules and suggested he not wear any of the deducted clothes, including his Rocky Wolverine boots, to court?!!

The devil is always in the details!

Don't Get Ripped Off When You Refinance Your Mortgage

Every day I get bombarded by mortgage refinancing ads: TV, radio, email, pop-up & banner ads.

It seems like they're all saying you can roll up your car loan and non-deductible credit card debt or cash out your home's equity into a new bigger, better mortgage. Then they have the legalese guy muttering too quickly to understand: "Talk to your tax professional for deductibility rules" ... or words to that effect.

Of course they know no one will actually do this until after they've refinanced. I think the ads are misleading. The rules aren't really that difficult.

Make sure you understand the tax rules and how it will affect you before you refinance. Most people will not be able deduct all the interest on the mortgage described in these ads.

For the most part, you can only deduct mortgage interest on loans used to buy, build or improve a qualified residence. That means you can refinance the principal of your old loan plus any other loans used to buy or improve your home. If you use your mortgage to cash out funds to pay off other debt, the interest on that principal is not deductible.

Home equity loans that are less than $100,000 (or the fair market value of the home less any outstanding debt, which ever is less) are fully deductible regardless of how the proceeds are used.

In addition, the mortgage interest deduction is limited on mortgages over $1 million. If your loan is over $1 million the IRS provides worksheets to help you figure out what percentage is deductible.

If the original mortgage for your home closed before October 14, 1987, it might qualify as "grandfathered debt" and special rules apply. Take a look at IRS Publication 936, Home Mortgage Interest Deduction for more details.

Oh, and watch out for point on refis. They are not fully deductible in the first year. You must amortize them over the life of the loan.

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