Tax Considerations for Soap Makers

Paul Clough, C.P.A.
Okay, are we ready.  Alright.  Is everybody happy with the taxes that they pay?  The amount of taxes?  No? No?  Are you confident that you are getting the best quality of tax preparation, that you’re getting all the deductions that you deserve?  You’re confident that you are?
Does your accountant give you proactive advice in how to save on your taxes for the future?  Well, there’s good news and bad news.  The bad news is that studies generally show that people pay too much taxes.  They pay more than they should.  They’re not taking all the deductions that they can, that there’s stuff out there, there’s deductions that are left on the table.  Not everybody falls into that category, but studies generally show that there’s plenty of people that could save money on their taxes. 
So we’re going to talk about a few options, and some of the mistakes people make when they’re doing their taxes.  And planning.  Because the biggest mistake people make is that they fail to plan.  They think that, oh, I’ll bring him this bag of receipts and so on, on April 15, and he’ll put everything together.  The trouble is, when somebody brings me a bag of receipts on April 10, and say, can you get it done by the 15th; unfortunately, no one, no matter how good a person is at preparing taxes, you can’t go back and recreate what was done last year.  All you can do is take that sack of receipts, put them together and figure out how to prepare that person’s tax return right then.  You can’t go back and implement plans for the prior year.  You can only do it, you’ve got to do it going forward.  
So, there’s very few things that you can do on April 10 or 15 to help a person with their prior year taxes.  The Supreme Court Justice William Rehnquist said, “There is nothing wrong with the strategy to avoid the payment of taxes.  The Internal Revenue code doesn’t prevent that.”  Planning to reduce your tax bill is not illegal.  
Another Supreme Court justice said, he lived in Alexandria, Virginia.  There was two ways for him to get home, one was to go over a bridge, which was a toll bridge.  So if he wanted to get home quick, he could pay the toll.  Not a problem.  If he wanted to save the money, he could go out of his way and go over the free bridge, and okay, it took him an extra half an hour to get home, but he saved the money.  That wasn’t illegal to do that, and by the same token, it’s not illegal to figure out ways to reduce your taxes.
Tax evasion is when you do things that are not legal to avoid taxes.  Avoiding taxes isn’t illegal, but you can do things to avoid the taxes that are illegal.  That’s tax evasion.  
There’s a couple of things with tax planning, it’s financial defense.  Financial offense is making more money.  You figure out ways, you work more, you find a higher paying job, whatever.  That’s financial offense.  Defense is when you figure out ways to reduce your expenses and one of your major expenses is taxes.  So, if you can figure out ways that you can reduce your tax bill, you’re ahead of the game.
Tax planning basically guarantees results.  If you set your tax reduction strategy up correctly, you’re going to reduce the tax bill.  So it’s a guaranteed result.  It’s not oh, well, you know I’ll try to work more and I may make more money.  In this case, if you plan correctly, and you work out your strategies, you’re going to reduce your tax bill.
So, I’m going to go through the next two slides quicker than I usually do.  I think we’re probably going to be a little short of time. 
 But there’s a few things that go into your tax return.  Taxable income, is basically all of your income.  It’s your earned income, your wages, your interest and dividends, capital gains, when you sell any assets, of course, you may have capital gains or capital losses.  Pension, IRA, and annuity income.  Rents and royalties, alimony, gambling winnings and illegal income.  The IRS basically doesn’t care how you make your income.  They just want you to report it.  You could be a bookie.  They don’t care as long as you report the income.  Al Capone didn’t get caught for bootlegging.  He went to jail for tax evasion. 
So, the IRS, as far as they’re concerned, hey, I don’t care how you make your income, just pay your taxes.  Report the income and pay your taxes.  
Then you have adjustments to income.  These are towards the bottom of page 1 on the tax return, they’re IRA contributions, moving expenses, half of the self-employment tax, the self-employment health insurance, retirement, alimony and student loan interest.    PC – No, this… okay, hold that until the end and ask me when I’m finished, because this would really be part of your business expenses.  Okay, which aren’t here.  That actually, when you do your Schedule C, that’s going to be part of taxable income.  Because you’re going to do a Schedule C for your business, you put it all together and this would be one of the expenses for Schedule C, okay?
Okay, then you’ve got deductions and exemptions.  Deductions, you’ve got medical, and the medical deduction has gotten worse and worse.  Back, now I guess it was about twenty years ago, thirty years ago now, wow, time flies when you’re having fun.  Thirty years ago Reagan implemented a 7.5% exclusion on medical expenses.  Which means that you take all your medical expenses and then you’ve got to reduce that total by 7.5% of your adjusted gross income.  So, you could end up, I mean, you could spend $10,000 on medical and end up with a few hundred dollars in deduction.  Now it’s gone up to 10%.  So, it keeps getting worse.  Now you’ve got a 10% exclusion.  So you add up all your medical and then you take 10% of your adjusted gross income, and reduce your deduction by the 10%.  So, the medical/dental deduction has really gotten bad.  
And you’ve got state and local taxes.  If you’re in Florida, you can deduct sales taxes; other states you’ve got income tax, so you can deduct the state income tax.  But in Florida, we don’t have a state income tax so we can deduct sales taxes.  And you can deduct property taxes for whatever number of properties that you own.  You could have five houses and deduct the property tax on all five houses.  
You can deduct foreign taxes.  And you can deduct interest, limited interest.  You can deduct mortgage interest, you can deduct up to two houses; so your personal residence and a second house, you can deduct mortgage interest.  You can deduct interest on investment accounts.  So if you have some interest related to, like a margin account, you can deduct that interest.
Casualty and theft losses, that’s if you have… if your house burns downs, and your insurance doesn’t cover the whole cost, you can deduct the amount of excess loss that you had.  
Charitable gifts.  You can deduct charitable gifts to the extent of your basis in the charitable gifts.  And then you have miscellaneous itemized deductions.  The other day, Kevin Dunn mentioned education.  You can deduct education related to your current profession, so if you have, you’re a nurse, so you could take any CTE that you have to do, anything like that, you can take under the miscellaneous itemized deductions.  Unfortunately, this also is subject to an exclusion, which is 2% of your adjusted gross income.  So, here again, you’re going to get the amount of your deduction reduced by 2% of your adjusted gross income.  Not as bad as the medical, but still you’re going to lose 2%.  So you’re better off, again, if you can move those expenses someplace else.
Now you’ve got to add all those things together, you end up with taxable income.  You’ve got, you started off with your adjusted gross income, then you took your itemized or standard deduction, then you took your exemptions, your personal exemptions – yourself, your spouse if you’re married filing jointly, and any dependents that you have.  That ends up coming to the taxable income.  
You take and find your tax bracket based on how you’re filing and that’s how you end up with your tax rate.  
Then, you get into tax credits.  Tax credits – education credits if you’re kids are going to school, college, not lower schools, but when they go to college, you’re going to end up with the ability to take a deduction to take a deduction for an education credit.  It’s not going to offset the cost of the college, I guarantee it, but it’s better than nothing.  Then you’ve got foreign tax, you’ve got general business credits, you’ve got low income housing credits, and renovation credits.
So, basically, you’ve got two kinds of dollars on your tax return.  Pretax dollars, and after tax dollars.  One of the key things is trading after tax dollars in so you can make them pretax dollars.  Because, once you can reduce that amount of taxable income, you’re going to reduce the taxes, you’re going to reduce the tax rate, you’re going to be ahead of the game.  So, in your case, most of you have a small business, you have ways you can trade some of those after tax dollars and make them into pretax dollars.  Not always easy, but you can.  
Any questions up to this point?  
So anytime you can move those after tax dollars into pretax dollars, you’re going to save money.  And that’s some of the things I’m going to cover in the next slides.
Now, the second big problem, big mistake people make is they have audit paranoia.  “Oh, I don’t want to take that deduction because it might open me to an audit.”  It used to be home office, “Oh god, that’s a trigger for the IRS; if I try to take home office, they’re going to audit me.”  Well, you know that’s just not the case.  If you have an S-Corporation, your chance of being audited is about a half of one percent.  On average an individual has less than a 1% chance of being audited.  And, even ones, the higher you go up in the tax bracket, the more likely you are to be audited.  So, if you make a million dollars, okay, now you’re getting into an area where you have a bigger chance to be audited.
If you file a Schedule C, and you make more than $100,000, you have a 3.6 chance of being audited.  But, those are the people that I would say, okay, you shouldn’t be a Schedule C, you should be an S-Corp anyway.  And if you’re an S-Corp, you’re going to do two things, you’re going to reduce your chance of being audited, not increase it, and you’re going to reduce your self-employment tax.
So, now we get to what we were talking about the other day, business entities.  These are the basic ones, there’s the LLC also which is kind of the flavor of the month, but if you do an LLC you’re going to have to come back to filing as one of these entities.  So, no matter whether you’re an LLC or not, you don’t file an LLC tax return, there’s no such thing.  You file as one of these and generally I tell people S-Corporation is the way to go.
So, as a sole proprietorship, like I told you the other day, you’re going to pay self-employment tax of 15.3% of whatever your net income is.  If you’re an LLC, you’re a single member LLC, and you’ve let the IRS decide for you what your filing status is, it’s going to be sole proprietorship and you’re going to end up paying 15.3%.  Good for the IRS, bad for you.  
If you’re an S-Corporation, and this is pretty much the sweet spot.  Obviously, there’s always a down side to these things, in an S-Corporation you can split your proceeds so that at the end of the day you can say, “okay, I’m going to make $50,000 this year; I’m going to take $25,000 of that and it’s going to be salary, and $25,000 is going to be investment income.”  Okay?  Now, that means that you pay 15.3% on the salary, so now, you just reduced your self-employment by 50%.  You’re saving 50% there, the downside is that of course you’ve got to file payroll tax returns during the year.  So, yeah, you’re going to have to do some extra work but if you can save $3-4 or $5000, isn’t it worth a little extra work during the year to save it.  So that’s the S-Corp, and this is an illustration of S-Corp/FICA; if you’re making $80,000 as a sole proprietor, you’re going to pay self-employment tax of $11,304.  Your net then will be $68,696. As an S-Corp, you’re going to pay $40,000 salary, $6120 FICA, and then your net will end up being $73,880, over $5,000 savings.
Okay. Mistake number four.  Having the wrong retirement plan.  There’s a lot of different options for retirement plans.  And, probably the easiest one for most people is just the traditional IRA.  You can even do it when you’re filing your taxes in April.  You have until you file your taxes on April 15 to set up a traditional IRA.  Unfortunately, it’s only $5500 for most people, so if you go and file, say, okay, I want to set up my IRA and put $5500 in it, that reduces your taxable income by $5500, so you defer paying taxes on $5500 at that point.  Which is okay, it’s better than not doing anything, but you have other options if you plan ahead. 
A simplified employee pension is one option.  That allows you to put away quite a bit more; the downside is, if you’ve got employees.  If you’re in it just by yourself, okay, because most of these pension plans are set up under IRS scrutiny and they have to be non-discriminatory.  Which means that you cannot make them just for yourself.  If you make them just for yourself, it’s not going to meet the standard and it will be rejected by the IRS.  So, you’ve got to include, and there are some options about how much people make and how long they’ve worked for you and so on, but it applies to everybody.  So, typically you’re going to have to include employees.  And if you’ve got, you’re at the point where you have several employees, that may not be all that attractive to you.  I’ve had clients in the past that they just wouldn’t do a retirement plan because they would have to give more money to the employees.  Well, to me it’s kind of short-sighted, you’re ending up with the lion’s share of the deduction, but, you’ve got to look at your particular situation.
From the SEP, we get into a simple IRA.  Don’t confuse the simple IRA with a traditional IRA.  Traditional IRA is a individual plan that you can set up anytime up until April 15, even for the prior year.  Up until the time you file, April 15, you can do a contribution to that traditional IRA.  The simple IRA is a payroll contribution plan.  You take and say, okay, I’m going to set up a simple IRA, I want to put 10% of my payroll into that simple IRA.  And if you’re making $1000 a week, that means $100 goes into the simple IRA for you.  In addition, your company that you have, adds 3% to that $100, so now, you’re going to have $103 going into the simple IRA – I’m sorry, $130 is 3%; so you end up being able to put away quite a bit of money.  There isn’t any administration, which can get into, in the next few slides I’ll talk about administration.  In this case, a simple IRA is a very easy plan, there’s no administration on your part other than withholding the money and paying it into the individual simple IRA’s that are set up for each of the employees.  Here again, it’s got to be nondiscriminatory so if you’ve got five employees, you’ve got to offer it to everybody.  Okay, now my experience has been, the hourly people do not take advantage of it for the most part.  So, it’s basically going to benefit you.  It’s available to them, it’s up to them whether they take advantage of it or not; and that’s why it’s such an easy plan.  The IRS says, here’s what you have to do.  As long as you adhere to the rules, offering it to people, that’s all you have to do.  You’re the only one that takes advantage of it, hey, so be it.
But what this allows you to do, just like a traditional IRA, you’re going to defer income to sometime in the future.  Now, like most of these plans, there are penalties if you withdraw it early.  If you withdraw money from pretty much any of these plans before 59-1/2, you’re going to pay a 10% penalty.  So, you’ve got to keep that in mind.  But that’s a small downside because after 59-1/2, you can take any amount, you can take it out gradually, you can take out one big lump sum if you want and do whatever you want after 59-1/2.  But once you take it out, you’ve got to remember you’re going to, it’s going to add to your taxable income in that year.  
In the simple IRA, your limit is up to $12,000 deduction, plus, if you’re over 50 you can take out a catch-up deduction of $2500 for a total of $14,500 you can put into it each year.  And it goes up, usually it goes up $500 every year, so I think now, this year, for 2015, it’s going to be $12,500.
Any questions so far?
Okay, now we get into plans that people have heard more about.  401(k)s, most people have either had a 401(k) at one of their jobs, bigger companies typically have 401(k)s.  You can contribute up to 25% of income, the maximum contribution is $52,000.  You can defer up to $17,500 on a 401(k).  At 50, you can have a $5500 catch-up based on age; the employer then contributes up to 25% in addition to what you put in, maximum contribution is $52,000.  In a 401(k), you can take a loan, most of the others you cannot.  In a 401(k) you can set up with loans.  Unfortunately, most 401(k)s have administration.  So typically what happens when you have a 401(k) is you contract with a third party administrator, who’s going to take and administer the 401(k) and do all the administration.  So there’s some expenses to having a 401(k).  If you’re the only employee, there’s some provisions there for a simplified administration, for a solo 401(k), but if you’re in a situation where you’ve got any employees, you’re probably going to end up having to contract with a third party to do the administration.  Because I guarantee you, you do not want to be filling out the paperwork that the IRS requires for a 401(k).  I mean, it can be, it’s like doing a tax return.
  PC – Yes, all these would be yearly, yes.  Now remember, that is the maximum contribution is, you have a contribution based on what your payroll deductions are.  That’s $17,500.  Then the $52,000 refers to the employer additional contribution, which is, typically a profit sharing, think of it like profit sharing.  Okay?  And that’s in addition to what you’ve already taken out of your pay.  Remember, when you have a plan which is a contributory payroll contribution type plan, the deduction to the corporation is the full amount of your payroll.  So, if you’ve got a situation where you’re paying yourself $2000 a month, and you take the maximum and put it into a simple IRA, the company is going to be deducting, your company is going to deduct $24,000 for wages.  Your W-2, though, is going to show, for you, taxable income of $12,000.  Because you’ve taken $12,000 of the $24,000 and put it into a simple IRA.  Okay?  So, it’s still a deduction from corporate income, but you’re not going to pay taxes individually on it because you’ve taken and put it into a retirement plan that’s going to defer the taxes on it, okay?
Now, this is the biggie.  When you get into the ability to do a defined benefit plan, you can really get into some big deductions.  But, in order to do this, you really need to have a substantial amount of income, of taxable income, because the contributions to this are based on a defined… there’s two types of retirement plans – defined contribution plans which is all the others I talked about, where you’re deciding how much contribution I want to make – and a defined benefit plan, what you’re doing is, when they do the calculation, saying, okay, based on the plan, this person wants to receive 100% of their normal income when they turn 65.  So, this person is aged 55, so that means that they have to put away “X” amount until they are 65 in order to generate income that’s going to equal what they’re getting today.  Okay?  That’s why this is always done by a third party, the calculations to arrive at the numbers here are really complicated.  This is actuarial calculation.  So, you can end up with huge deductions but you need to have the income there to justify doing it.  Okay?
Another mistake a lot of people make is not employing their children.  And you can’t do it if you’re a corporation.  You cannot, because when you’re in a corporation, they’re going to be employees in a corporation.  So you’ve got to meet all the requirements that are out there for an employee. But if you are a sole proprietor, it’s a different thing.  They’re your kids, you can employ them after they’re seven years old.  The first $6200 is tax-free, because that’s the standard deduction.  And then, the next $9000 is only at 10%.  You’ve got to pay a reasonable wage.  And you need to have a written job description, timesheets and the best thing would be to write a check.  Okay, now, the account needs to be set up in the child’s name.  You can’t just say I’m going to take “X” amount in my own account and I’m going to separate it, that’s my kid’s piece.  Uh, uh, it doesn’t work.  You’re not going to have to pay FICA on the child’s earnings.  Now, what this does is allows you to take and set up, let’s say, a college plan for your child and fund it with money that he earns or she earns working for you.  So, let’s just assume for a minute that you own some rental property.  And, you pay your kid to go and mow the lawn every week.  Saturday, he goes off, he mows the lawn on the rental houses, and you pay him what you would pay for outside service.  You can’t decide to pay him 10 times what you pay an outside service, but, you know there’s some leeway there, obviously you can pay him a little more.  From your viewpoint, he’s doing a better job.  Okay, he’s more careful with it, he does a neater job and so on.  Okay, so then you take that money, take it out, make sure it comes out of the business, so you write a check from the business, put that check into his account which is set up as a 529 college plan, so boom, it goes into his college fund.  And basically, here, you’re taking after tax money and you’re changing it to pretax money because you reduce your taxable income.  And you’re taking care of something that you would have to pay later after taxes.  
  PC – Yes, 17.
  PC – Yeah, if you are a corporation, you get into an employee/employer situation so, if you’re hiring somebody then, you’ve just lost the ability to …do it as a non-employee, because in this situation, the child is an employee of yours, right, so the way the rule is set up, you, as a self-employed person can hire your child and pay him something.  But when it gets into a corporation, it’s no longer you, it’s a corporation.  So, when you hire that child, it’s just like hiring anybody else.    PC – This is an advantage for a sole proprietor, disadvantage for a corporation.  
Okay.  Now we get into, and these can be, these things here get into some of the bigger money these days, because the cost of healthcare has gotten so big that being able to take any kind of medical benefits in your business has got to be a big thing.  So, you can set up an employee benefit plan where you hire your spouse and their pay is the insurance, not necessarily the insurance but all medical expenses.  It still has to be reasonable.  But you can set it up so you reimburse the employee, who happens to be your spouse, for all the medical expenses.  For the self, for the spouse and for the dependents.  This can be a big deal.  If you’re in a situation where your health insurance is killing you, well, you set it up so it’s a deduction for you.  You set up what’s called a MERP or a 105 plan.  A MERP is a Medical Expense Reimbursement Plan.  It’s a written plan, detailing how the expenses are going to be paid and how it applies to that individual, what it pays.  And it can cover virtually everything.  If your child needs braces, you can set it up so it’s going to pay for braces, even non-prescription medications.  Now, the thing, you’ve got to keep it simple here.  When I say non-prescription medication, it still has to be prescribed by a doctor.  So a doctor has to say to you, look, I want you to take an aspirin every day.  That’s a non-prescription medicine, but now the doctor has told you, so when you go buy that aspirin, that bottle of aspirins, that’s covered under the plan.  Because the doctor told you that you need to take those, that aspirin every day.  That now becomes a requirement, a medical requirement, even though it’s a non-prescription medicine, it’s still covered.  If you went and bought some cough medicine because you’re getting a cold, that would not be covered unless a doctor had told you to go buy it.
  PC – Oh you should.
  PC – Yeah, I mean, again, that comes into when you’ve got several employees it can get problematic because, again, it needs to be non-discriminatory, and when it comes to something like this, obviously the employee if you have one, is going to want to take advantage of it.  Most, some of the things like this, are pretty much a situation where it’s just you and you’re going to then hire your spouse and their pay is going to be the medical expense reimbursement.  And again, this would be in a sole proprietorship.  There are plans that we can do when it comes to corporations, and they do similar things.  But it’s still, this is more for a sole proprietorship as opposed to a corporation.  And then, there are restrictions when you get into an S-Corporation because there’s a lot of restrictions in the IRS code when you’re a 2% shareholder in the S-Corporation, things are excluded, this would be one of them.  
So in a MERP/105 Plan, it’s a written plan, documents are required.  There’s no prefunding, so it’s not like you’ve got to put away $1000 per month in a separate account or something.  You certainly, one of the things you can pay is health insurance, so when you want to have health insurance that the company can pay for because you don’t want to get into a situation where you don’t have health insurance.  You set up the company to pay all the expenses but, if something catastrophic happens, you don’t have anything to fall back on.  You need to have at least a high deductible health insurance that you can fall back on.  So, god forbid you get cancer, and you don’t have any kind of health insurance.  If you have a high deductible plan, you can pay the first $5000, high deductible means that the health insurance has a deductible of at least $2500.  Typically what you do is you get one with about $5000, so you pay the first $5000, as a deduction, then the health insurance kicks in, so if something catastrophic happens, the health insurance is there to back you up.  If you have the first $5000, you pay the $5000 deductible, but now your treatments are still going on, you’re still doing chemo or whatever, now your health insurance plan kicks in, and it’s going to keep you from running into bankruptcy.  Medical costs today, it’s pretty easy to get into trouble.  
This is going to minimize self-employment of course, because you’re paying this and it’s reducing your net income on your Schedule C, on the self-employment income.  
I already talked about the high deductible.  You can get into a Health Savings Account.  This is one of the things you can do even as a corporation.  You can set up a Health Savings Account.  In a Health Savings Account, again, you have the high deductible health insurance plan, and then you contribute from your pay a certain amount, $3300 to $6600 a year goes into the Health Savings Account and that goes to paying for any health costs.  Now the advantage of the HSA is that it’s not one of those use it or lose it plans.  Some of the other plans, if you don’t use it by December 31, you just lose it.  In this one it carries over to the next year.  And, an HSA, I know people that set up an HSA and basically they use it like an IRA.  Because if you keep adding money into it and you never use it, when you get to be 65 and now you’re subject to Medicare, you can then start withdrawing the money from that plan as if it were an IRA.  So, it’s a pretty nice set-up.  
Number Seven Mistake is Missing a Home Office deduction.  And this one of those things that people are always “Oh god, that’s going to expose me to an audit!  They’re going to audit me if I take a home office deduction.”  Well, years ago that might have been true but today they have relaxed the rules.  The rule now is you’ve got to use a space exclusively and regularly for administrative office, management activities of your trade or business.  You don’t necessarily have to do it, do the business right there.  The original case that caused all the changes was a medical doctor, I think it was an anesthesiologist, so he worked out of a hospital so that’s where the earning was, but he maintained an office in his house to do all of his billing and maintaining his medical records and so on.  Based on the old rule, the only way you could deduct a home office is, if that’s where the earning process was.  The IRS disallowed his deduction.  After that, the rule was changed so that it covers the administrative or management activities.  And you have no other fixed location where you conduct substantial administrative, so if you’ve got an office, like I have in the building out front, I cannot turn around and take a home office deduction, because I’ve got an office where I conduct my business out of and where I do all of my administrative activities, and management activities.  So I can’t, in addition to that, turn around and take a home office deduction.  
Most of you don’t have that same problem.  But if you rented a warehouse where you did all your soap making, that could be a problem.  If there wasn’t any space there to do any kind of administrative work, I mean it was just a bare warehouse type of place, you could make a case that you could also take something in your house.  Any question on that by the way?
Basically, what you do is you measure, you take the full dimensions of the house, take the square footage and then, you get a percentage, and, you get a business use percentage for whatever space you’re using.  And you apply that to all the expenses of the house.  Your mortgage, homeowners insurance, your maintenance of the house, even depreciation on the building.  It can turn into a pretty decent deduction for you.  And this does not anymore raise a red flag for the IRS so wash it out of your mind that, oh boy, you know, it’s going to raise a red flag and I’m going to get audited.  Forget about it, it’s not the situation anymore.  
So you can see here, the whole house is 1500, you use 144, you apply it to the mortgage, property taxes, utilities, security, cleaning, office furniture, depreciation.  Now, even though you get a deduction for mortgage and property taxes on Schedule A, you want to use it here because it’s going to reduce the taxable income, the business taxable income, and therefore reduce the self-employment tax.  This is where you want to use it if you can.
Remember by having an office in the home, you’re going to increase your business miles.  Because now everything, now your base is the home, anyplace you go it’s going to be business miles.  You go out to pick up supplies, you drive 300 miles to town, and you’re going to have a nice deduction.  Now, like everything else, there’s some downsides, if you sell the house you’ve got to recapture the depreciation, but you still keep the tax-free exclusion on the rest of it.  But you do end up with some recapture at the time you sell the house.  
Here again, number eight is Missing Car and Truck Expenses.  When you get into car and truck expenses, typically people will say just take the standard deduction, that’s what the IRS has calculated, and that must be pretty close to what’s correct.  Well again, the IRS is not your friend.  They’re not making, that calculation is based on the universe.  It’s the person with an Escort, the person with a Yukon.  So, the person with the Escort, okay, they’re probably ahead of the game by taking a standard deduction, or if you’re driving an older car.  If you’re driving a car that’s 10 years old and there’s not much depreciation left in it and so on, as long as the operating expenses aren’t real high in it, maybe you’re better off with the standard deduction.  But if you’re driving a fairly new car, and it’s a bigger car, you’re probably better off taking the actual expenses.  Because your insurance is going to be high, your gas costs are going to be high, your maintenance costs are going to be high, and you’re better off calculating the actual expenses.  Typically when people come in to me each year, I’ll take and do it both ways to see, if it’s not obvious to me.  I’ve been doing this for so long, I can look at it and have a pretty good idea, okay, you’re better off taking the standard deduction, the standard rate.
I had a guy a few years ago who was in a service business.  And he drove all over, he put on 50-60,000 miles a year.  He had an old van that he drove, probably 20 years old, so he had no depreciation from it.  And we took the standard deduction for him.  Well, the mileage at that time was, a few years ago, was probably 40 cents a mile.  But 40 cents a mile times 55,000 miles was a lot of money for him.  If we took the actual expenses, it would have been a lot less.  But if he went out and bought a new van, and at that point would have to do a recalculation to see, he probably would have been better taking the actual expenses versus the standard.  So you’ve got to kind of look at your own situation and see where you are, these are the costs from AAA for a small sedan.  You can see the variance there from the small sedan up to a mini-van.  So, it’s quite a disparity.
Next thing is Missing Meals and Entertainment.  Here is another case where people always say, “Oh, it’s a red flag.”  Look, if you keep the record that is required by the IRS, it doesn’t matter whether it’s a red flag or not, even if you get audited.  If you’ve got the backup, you’ve got the deduction.  So, IRS says, look you need, they need to be clients or prospects or referral sources or business colleagues.  Only 50% of the expense is deductible, because the IRS looks at it and says okay, if there’s two people having a meal, one of them is you.  And you can’t deduct your own meal.  But you can deduct a meal for the other person.    PC – Yeah.  
Now you can also deduct home entertainment.  If you have a barbecue in the summer, and you invite a whole bunch of people, those can all be prospects.  And, you know, you put out a table of your products, and make them available to people, there’s no reason why that barbecue can’t be deductible.  You do a home party for the holidays, same thing.  So, now the thing is, you need to document…   PC – Yeah that would be deductible.  It’s not…. There still has to be some business discussion.  It can’t be just a pure entertainment.  But the business discussion, it doesn’t have to be, it doesn’t have to take up the whole time.  You know, if you’ve got a 10-minute talk about business and okay, this is where, say a holiday party, you know you spend 10 minutes talking about where the company’s going next year and everything then is deductible.    PC – Yeah, oh yeah, absolutely.    PC – Well, that would be deductible but it’s marketing as opposed to entertainment expense.    PC – It would go along with, if you’re going to visit a client, I had people in the past who where nurses but they went out to doctors’ offices to talk to doctors about their company.  And they would almost always bring doughnuts, or doughnut holes or muffins, or something.  Well, that’s more along the line of marketing, as opposed to an entertainment expense.  Like she said though, it’s 100% if you term it not as an entertainment expense.  Typically entertainment would be more one-on-one situations, you know, or a limited number of people.  
So, now, what the IRS says is that what you have to record is how much, when, where, what the business purpose was and what the business relationship is.  So, alright, I spent $100, it was at the Residence Inn, although they don’t have a restaurant, but let’s assume for a minute that they did.  It was on, you’ve got to put the date on it, what the business purpose was, what we discussed, a new contract, and what the business relationship is to the prospect.  So, in your case, you take somebody to lunch who is, who has a flea market, and you want to talk to him about, what are the possibilities of my opening a stand at your flea market, and what kind of business are you doing, what’s your volume, you know, what can I expect to find.  How many soapers are there already there?  You might find a flea market and there’s already 10 soapers there, you know, what are you going to be, one more soaper unless you have a particular niche, you make your soap out of goat’s milk or you’ve got honey soap or whatever it is, you have a niche and none of these others fall into that niche.  So, these are the things that are required, so you have to make sure you take that receipt and right away on the back of the receipt you write down… generally the receipt is going to show the date and the place and everything.  But what you’ve got to put down is what the purpose was and what the relationship was and who was there.
  PC – We’re getting used to it.    PC – Usually, it’s better because like you just said, most of the receipts today are thermal paper and the thermal paper, in six months it’s gone.  The scanning is probably a better process.  Now, when you scan, the whole thing with scanning is being able to catalog it and put it in the right place so you can retrieve it.  Otherwise, all you got is a file full of crap, you know.  You’ve got to be able…   PC – Yeah.
Okay, and here is the biggest error of all.  And that’s not taking advantage of the tax coaching service that I offer.  Which is to help you with a tax plan.  And this is one of the things I do, is set up a written tax plan.  I take your individual paperwork and actually set up a written proposal and tax plan which shows you, you can do these things and it may be set up an S-Corporation, it may be set up a MERP, it may be whatever applies to your situation.  And then, at that point, it’s up to you whether you try to implement it yourself or you have me implement it.  So, obviously, you know, my recommendation is that I implement it, but you know, it’s your option at that point.  I’ve seen too many times though, somebody ends up with a written plan, they’re going to do it but it goes in the drawer and they’re going to do it when they get time and the time never comes.  Because how much time do you have?    PC – Of course, absolutely.
Okay, a couple of things, I think I talked to somebody the other day, they asked me about a hobby versus business.  And, the IRS has rules, specifically about a hobby versus business.  And it all revolves around the deduction of losses.  It has nothing to do with income, net income, because anytime you have net income, it is reportable.  The problem arises when you have losses in your business.  IRS says you’ve got to make money three out of five years in order to have a viable small business.  I’ve had people come to me and they have a dog breeding, they say, I have a dog breeding business.  Unfortunately, they lose money all the time.  Well, they can’t deduct anything.  Because, they never ever make any money in the business, and they’re just trying to be able to deduct the expenses for their hobby.  And I appreciate that but the IRS says no.  
Sales tax requirements – if you have a business, you’re subject to sales tax.  If you’re selling soap, if you’re selling whatever, you’re subject to sales tax.  There is nothing in the sales tax code about you’re excluded because you’re a home based business.    PC – Depending on the state, and you’re selling out of state, you probably don’t have to deduct, as long as you keep records of shipping.  Okay, you can’t sell in your state to a non-resident and make that non-taxable.  If you’re selling in the state, doesn’t matter who you’re selling to, it’s taxable.  If you’re shipping it out of state, it’s probably non-taxable.  
Nexus means, it’s a technical thing with the sales tax bureaus, and that is, if you have some connection with that other state.  Let’s say you had a vacation home in Colorado, you lived in New Mexico, and you were shipping from New Mexico to Colorado, you probably would be taxable.  Because that vacation home would give you nexus with that state.  The sales tax people would use it as a nexus situation.  Now, Congress right now is looking at, or they have looked at, god knows if they’ll ever…. You know I wouldn’t bet on Congress ever doing anything, but one of the things that the states are all after Congress to do is make interstate sales taxable.  Forget nexus, everything will be taxable, particularly internet.  That’s what they’re going after is the internet sales.  Selling on eBay, if you’re selling on Amazon, they want that all to be taxable.  And, it would open up a major problem for most people, because the sales tax rules in other states are horrendous.  If you made it state by state, wow, you would have a real administration problem as a small business.  Any questions?  You can get me later if you have any other questions.

 

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