August 2013 – Page 3 – Financial Dream Team

Tax Planning for Small Business Owners

Tax planning is the process of looking at various tax options in order to determine when, whether, and how to conduct business and personal transactions to reduce or eliminate tax liability.

Many small business owners ignore tax planning. They don’t even think about their taxes until it’s time to meet with their accountants, but tax planning is an ongoing process and good tax advice is a valuable commodity. It is to your benefit to review your income and expenses monthly and meet with your CPA or tax advisor quarterly to analyze how you can take full advantage of the provisions, credits and deductions that are legally available to you.

Although tax avoidance planning is legal, tax evasion – the reduction of tax through deceit, subterfuge, or concealment – is not. Frequently what sets tax evasion apart from tax avoidance is the IRS’s finding that there was fraudulent intent on the part of the business owner. The following are four of the areas most commonly focused on by IRS examiners as pointing to possible fraud:

Failure to report substantial amounts of income such as a shareholder’s failure to report dividends or a store owner’s failure to report a portion of the daily business receipts.
Claims for fictitious or improper deductions on a return such as a sales representative’s substantial overstatement of travel expenses or a taxpayer’s claim of a large deduction for charitable contributions when no verification exists.
Accounting irregularities such as a business’s failure to keep adequate records or a discrepancy between amounts reported on a corporation’s return and amounts reported on its financial statements.
Improper allocation of income to a related taxpayer who is in a lower tax bracket such as where a corporation makes distributions to the controlling shareholder’s children.

Tax Planning Strategies

Countless tax planning strategies are available to small business owners. Some are aimed at the owner’s individual tax situation, and some at the business itself, but regardless of how simple or how complex a tax strategy is, it will be based on structuring the strategy to accomplish one or more of these often overlapping goals:

Reducing the amount of taxable income
Lowering your tax rate
Controlling the time when the tax must be paid
Claiming any available tax credits
Controlling the effects of the Alternative Minimum Tax
Avoiding the most common tax planning mistakes

In order to plan effectively, you’ll need to estimate your personal and business income for the next few years. This is necessary because many tax planning strategies will save tax dollars at one income level, but will create a larger tax bill at other income levels. You will want to avoid having the “right” tax plan made “wrong” by erroneous income projections. Once you know what your approximate income will be, you can then take the next step: estimating your tax bracket.

The effort to come up with crystal-ball estimates may be difficult and by its very nature will be inexact. On the other hand, you should already be projecting your sales revenues, income, and cash flow for general business planning purposes. The better your estimates, the better the odds that your tax planning efforts will succeed.

Maximizing Business Entertainment Expenses

Entertainment expenses are legitimate deductions that can lower your tax bill and save you money–provided you follow certain guidelines.

In order to qualify as a deduction, business must be discussed before, during, or after the meal and the surroundings must be conducive to a business discussion. For instance, a small, quiet restaurant would be an ideal location for a business dinner. A nightclub would not. Be careful of locations that include ongoing floor shows or other distracting events that inhibit business discussions. Prime distractions are theater locations, ski trips, golf courses, sports events, and hunting trips.

The IRS allows up to a 50 percent deduction on entertainment expenses, but you must keep good records and the business meal must be arranged with the purpose of conducting specific business. Don’t hesitate to call us if you need assistance with recordkeeping requirements.

Important Business Automobile Deductions

If you use your car for business such as visiting clients or going to business meetings away from your regular workplace you may be able to take certain deductions for the cost of operating and maintaining your vehicle. You can deduct car expenses by taking either the standard mileage rate or using actual expenses.

The mileage reimbursement rates for 2013 are as follows: 56.5 cents a mile for business, 24 cents for moving and medical miles and 14 cents per charitable mile.

If you own two cars, another way to increase deductions is to include both cars in your deductions. This deduction works because business miles driven is determined by business use. To figure business use, divide the business miles driven by the total miles driven. This strategy can result in significant deductions.

Whichever method you decide to use to take the deduction, always be sure to keep accurate records such as a mileage log and receipts. If you need assistance figuring out which method is best for your business, please contact us.

Increase Your Bottom Line When You Work At Home

The home office deduction is quite possibly one of the most difficult deductions ever to come around the block. Yet, there are so many tax advantages it becomes worth the navigational trouble. Here are a few common tips for home office deductions that can make tax season significantly less traumatic for those of you with a home office.

Try prominently displaying your home phone number and address on business cards, have business guests sign a guest log book when they visit your office, deduct long-distance phone charges, keep a time and work activity log, retain receipts and paid invoices. Keeping these receipts makes it so much easier to determine percentages of deductions later on in the year.

Section 179 expensing allows you to immediately deduct, rather than depreciate over time, up to $500,000, with a cap of $2,000,000, worth of qualified business property that you purchase during 2013. The key word is “purchase”. Equipment can be new or used and includes certain software. All home office depreciable equipment meets the qualification. Also, if you purchase more than $500,000 in equipment, you can expense the first $500,000 and then depreciate the rest. In addition, a “Bonus Depreciation” of 50 percent is allowed on qualified assets (new equipment only–no used equipment and no software) placed in service during 2013.

Some deductions can be taken whether or not you qualify for the home office deduction itself. If you’d like to meet with us to learn more about home office deductions, please give us a call.

How to Save for College Tax-Free

According to the US Census Bureau, individuals with a bachelor’s degree have the potential to earn more than double the salary of those with just a high school diploma, so even though tuition and fees are on the rise, most people feel that a college education is well worth the investment. That said however, the need to set money aside for their child’s education often weighs heavily on parents.

Fortunately, there are two savings plans available to help parents save money that also provide certain tax benefits. Let’s take a closer look.

The two most popular college savings programs are the Qualified Tuition Programs (QTPs) or Coverdell Education Savings Accounts (ESAs). Whichever one you choose, try to start when your child is young. The sooner you begin saving, the less money you will have to put away each year.

Example: Suppose you have one child, age six months, and you estimate that you’ll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you’ll need to save $3,500 per year for 18 years (assuming an after-tax return of 7%). On the other hand, if you put off saving until your son is six years old, you’ll have to save almost double that amount every year for 12 years.

Financial Calculator: College Savings Planner
Use this calculator to help develop and fine-tune your child’s college education savings plan.

How Much Will College Cost?

Based on the survey completed for the 2012 Trends in College Pricing, the average cost for tuition, fees, and room and board for 2012-13 was:

$17,860 per year for 4-year public (in state) colleges and universities, an increase of 4.2% from the 2011-12 academic year.

$39,518 per year for 4-year private colleges and universities, an increase of 4.1% from the 2011-12 academic year.

According to Trends in Student Aid, in 2011-12, undergraduate students received an average of $13,218 per full-time equivalent (FTE) student in financial aid, including $6,932 in grant aid from all sources, and $5,056 in federal loans.

Saving with Qualified Tuition Programs (QTPs)

Qualified Tuition Programs, also known as 529 plans, are often the best choice for many families. Every state now has a program allowing persons to prepay for future higher education, with tax relief. There are two basic plan types, with many variations among them:

The prepaid education arrangement. With this type of plan one is essentially buying future education at today’s costs, by buying education credits or certificates. This is the older type of program and tends to limit the student’s choice to schools within the state; however, private colleges and universities often offer this type of arrangement.
Education Savings Account (ESA). With an ESA, contributions are made to an account to be used for future higher education.

Tip: When approaching state programs, one must distinguish between what the federal tax law allows and what an individual state’s program may impose.

You may open a 529 plan in any state, but when buying prepaid tuition credits (less popular than savings accounts), you will want to know what institutions the credits will be applied to.

Unlike certain other tax-favored higher education programs, such as the American Opportunity Credit (formerly the Hope Credit) and Lifetime Learning Credit, federal tax law doesn’t limit the benefit to tuition, but can also extend it to room, board, and books (individual state programs could be narrower).

The two key individual parties to the program are the Designated Beneficiary (the student-to-be) and the Account Owner, who is entitled to choose and change the beneficiary and who is normally the principal contributor to the program.

There are no income limits on who may be an account owner. There’s only one designated beneficiary per account. Thus, a parent with three college-bound children might set up three accounts. Some state programs don’t allow the same person to be both beneficiary and account owner.

Tax Rules Relating to Qualified Tuition Programs

Income Tax. Contributions made by an account owner or other contributor are not tax deductible for federal income tax purposes, but earnings on contributions do grow tax-free while in the program.

Distributions from the fund are tax-free to the extent used for qualified higher education expenses. Distributions used otherwise are taxable to the extent of the portion which represents earnings.

A distribution may be tax-free even though the student is claiming an American Opportunity Credit (formerly the Hope Credit) or Lifetime Learning Credit, or tax-free treatment for a Coverdell ESA distribution, provided the programs aren’t covering the same specific expenses.

Distribution for a purpose other than qualified education is taxable to the one getting the distribution. In addition, a 10% penalty must be imposed on the taxable portion of the distribution, which is comparable to the 10% penalty in Coverdell ESAs.

The account owner may change beneficiary designation from one to another in the same family. Funds in the account roll over tax-free for the benefit of the new beneficiary.

Tip: In 2009, the American Recovery and Reinvestment Act (ARRA) added expenses for computer technology/equipment or Internet access to the list of qualifying expenses. Software designed for sports, games, or hobbies does not qualify, unless it is predominantly educational in nature. In general, however, expenses for computer technology are not considered qualified expenses.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them. Thus they qualify for the up-to-$14,000 annual gift tax exclusion in 2013 (up $1,000 from 2012). One contributing more than $14,000 may elect to treat the gift as made in equal installments over the year of gift and the following four years, so that up to $70,000 can be given tax-free in the first year.

However, a rollover from one beneficiary to another in a younger generation is treated as a gift from the first beneficiary, an odd result for an act the “giver” may have had nothing to do with.

Estate Tax. Funds in the account at the designated beneficiary’s death are included in the beneficiary’s estate, another odd result, since those funds may not be available to pay the tax.

Funds in the account at the account owner’s death are not included in the owner’s estate, except for a portion thereof where the gift tax exclusion installment election is made for gifts over $14,000. For example, if the account owner made the election for a gift of $70,000 in 2013, a part of that gift is included in the estate if he or she dies within five years.

Tip: A Qualified Tuition Program can be an especially attractive estate-planning move for grandparents. There are no income limits, and the account owner giving up to $70,000 avoids gift tax and estate tax by living five years after the gift, yet has the power to change the beneficiary.

State Tax. State tax rules are all over the map. Some reflect the federal rules, some reflect quite different rules. For specifics of each state’s program, see College Savings Plans Network (CSPN). If you need assistance with this, please contact us.

Saving with Coverdell Education Savings Accounts (ESAs)

You can contribute up to $2,000 in 2013 to a Coverdell Education Savings account (a Section 530 program formerly known as an Education IRA) for a child under 18. These contributions are not tax deductible, but grow tax-free until withdrawn. Contributions for any year, for example 2013 can be made through the (unextended) due date for the return for that year (April 15, 2014). There is no adjustment for inflation; therefore the $2,000 contribution limit is expected to remain at $2,000 for 2013 and beyond.

Only cash can be contributed to a Coverdell ESA and you cannot contribute to the account after the child reaches his or her 18th birthday.

The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution. This benefit applies to higher education expenses as well as to elementary and secondary education expenses.

Anyone can establish and contribute to a Coverdell ESA, including the child and an account may be established for as many children as you wish; however, the amount contributed during the year to each account cannot exceed $2,000. The child need not be a dependent, and in fact does not even need to be related to you. The maximum contribution amount in 2013 for each child is subject to a phase out limitation with a modified AGI between $190,000 and $220,000 for joint filers and $95,000 and $110,000 for single filers.

A 6% excise tax (to be paid by the beneficiary) applies to excess contributions. These are amounts in excess of the applicable contribution limit ($2,000 or phase out amount) and contributions for a year that amounts are contributed to a Qualified Tuition Program for the same child. The 6% tax continues for each year the excess contribution stays in the Coverdell ESA.

Exceptions. The excise tax does not apply if excess contributions made during 2013 (and any earnings on them) are distributed before the first day of the sixth month of the following tax year (June 1, 2014, for a calendar year taxpayer). However, you must include the distributed earnings in gross income for the year in which the excess contribution was made. The excise tax does not apply to any rollover contribution.

The child must be named (designated as beneficiary) in the Coverdell document, but the beneficiary can be changed to another family member, for example, to a sibling where the first beneficiary gets a scholarship or drops out. Funds can also be rolled over tax-free from one child’s account to another child’s account. Funds must be distributed not later than 30 days after the beneficiary’s 30th birthday (or 20 days after the beneficiary’s death if earlier). For “special needs” beneficiaries the age limits (no contributions after age 18, distribution by age 30) don’t apply.

Withdrawals are taxable to the person who gets the money, with these major exceptions: Only the earnings portion is taxable (the contributions come back tax-free). Also, even that part isn’t taxable income, as long as the amount withdrawn doesn’t exceed a child’s “qualified higher education expenses” for that year.

The definition of “qualified higher education expenses” includes room and board and books, as well as tuition. In figuring whether withdrawals exceed qualified expenses, expenses are reduced by certain scholarships and by amounts for which tax credits are allowed. If the amount withdrawn for the year exceeds the education expenses for the year, the excess is partly taxable under a complex formula. A different formula is used if the sum of withdrawals from a Coverdell ESA and from the Qualified Tuition Program exceeds education expenses.

As the person who sets up the Coverdell ESA, you may change the beneficiary (the child who will get the funds) or roll the funds over to the account of a new beneficiary, tax-free, if the new beneficiary is a member of your family. But funds you take back (for example, withdrawal in a year when there are no qualified higher education expenses, because the child is not enrolled in higher education) are taxable to you, to the extent of earnings on your contributions, and you will generally have to pay an additional 10% tax on the taxable amount. However, you won’t owe tax on earnings on amounts contributed that are returned to you by June 1 of the year following contribution.

Professional Guidance

Considering the wide differences among state plans, federal and state tax issues, and the dollar amounts at stake, please call us before getting started with any type of college savings plan.

How to Create a Progress Invoice from an Estimate

The U.S. economy may be picking up, but your customers are probably still being very careful with expenditures. If your company’s finances will allow it, you can help them out on sizable jobs by using progress invoicing, also known as partial billing or progress billing.

You could, of course, simply create invoices for smaller chunks of the job as they come. A smarter way is to build estimates for the entire job or sequential phases so your customer can see the big picture. You can still use progress invoicing to start collecting funds one segment at a time.

How to Proceed

First, be sure you have progress invoicing turned on. Go to Edit | Preferences | Jobs & Estimates | Company Preferences and make sure the Yes button is filled in next to the questions about estimates and progress invoicing.

Now create your estimate (these instructions are for QuickBooks Premier 2013; your steps may vary slightly). Go to Customers | Create Estimates. When you’ve entered all of the items you want to include in this phase of your project, click the Create Invoice button. This window will open:

Figure 1: You can decide how many of your estimate items will be included on your progress invoice.

By clicking one of these buttons, you can bill the customer 100 percent of what’s due on the invoice or just a percentage. But let’s say you and your customer have agreed that payment will be due in pre-defined stages, so click the third button and select one or more of the line items. Click OK. QuickBooks will display a new window that lets you select items and/or percentages of amounts due.

In our example here, we’re going to invoice the customer for two items, the blueprints and floor plans. So we selected the button next to Show Quantity and Rate and entered the full estimated quantity for each item in the QTY columns (if you chose Show Percentage, new columns would appear). It would look like this:

Figure 2: You can select specific items or percentages for your progress invoice.

Click OK. QuickBooks will return to your progress invoice, which you can save and print or email to your customer. Your original estimate will remain unchanged.

Tip: If you don’t want any of the zero amounts to appear on the progress invoice, go toEdit | Preferences | Jobs & Estimates | Company Preferences and make sure there’s a check mark in the box next to Don’t print items that have zero amounts.

Following Up

When you want to bill for another set of items on this estimate, simply repeat these steps.

Here’s an easy way to determine how much (if any) of the estimate has been invoiced. Go to the Customer Center and select the customer. Click the arrow next to the Show field and select Estimates. Any estimate that has a zero in the OPEN BALANCE column has been completely billed.

QuickBooks provides a report that tells you where you are with all of your progress invoices. Go to Reports | Jobs, Time & Mileage | Job Progress Invoices vs. Estimates. Your report will include the progress invoice you just created:

Figure 3: You can see what percentage of each estimate has been included on a progress invoice in this report.

More Options

What if you determine that you won’t have one or more of the items on the estimate? QuickBooks lets you quickly generate a purchase order. With your estimate open, clickCreate Purchase Order to select the item(s) needed and generate the form. You can also click Create Sales Order if one is necessary.

Estimates provide a useful way to fine-tune your bookkeeping and inform your customers about impending costs. They can also be confusing if you don’t keep up with them. We can help you determine when they’re a good idea and how to keep them organized. QuickBooks provides good tools here, but they do require some administrative control.

Month: August 2013

Tax Planning for Small Business Owners