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Jagella
12-30-2008, 11:47 AM
I'm working hard on building my design business, and I'm considering some tax reduction strategies. I'd appreciate some input on how I can keep my taxes low.

Although I would not cheat on my taxes, I'm wondering how common is it for small businesses to engage in illegal tax practices. Is it effective in lowering taxes? I understand that some people cash checks from business income and record it as personal income. Other business owners inflate business expenses or just invent an “expense” to lower taxable income. Sometimes personal expenses are claimed to be business expenses.

A more legal strategy is to make purchases for your business prior to officially setting up your business. If you're still an salaried employee you may be able to get higher tax deductions.

Other strategies include bartering which is an activity that the IRS finds hard to detect, employing family members to get a tax-deductible business expense, incorporating, and you might even try buying a condominium and rent it back to your business as office space. Paying the rent is a legitimate business expense, and the rent money you collect as owner of the condominium can be mostly offset as tax deductible expense of investing in business property.

Aren't you glad that the tax code is geared toward those of us who can afford to exploit it? :D

Jagella

SteveC
12-30-2008, 05:09 PM
I would advise everyone not to do anything illegal and to minimise your tax liability you really should speak with a specialist accountant... as we are a company things are a little different for us... however each year a couple of months before year end, we visit our accountant and he tells us what we need to do to minimise our tax. This generally involves paying ourselves more super, paying bills early or late, or such like... as that is legal and reduces the amount we have to pay the ATO... the secret is to gain this advice early enough to act on it.

It is also worth noting that if your company shows a constant loss for a number of years, this raises a red flag and you will be scheduled for an audit...

OldJack
12-30-2008, 05:46 PM
I'm working hard on building my design business, and I'm considering some tax reduction strategies. I'd appreciate some input on how I can keep my taxes low.
Jagella
Your best input would be from a qualified tax professional that can examine your specific business and offer professional advice.



Although I would not cheat on my taxes, I'm wondering how common is it for small businesses to engage in illegal tax practices. Is it effective in lowering taxes? I understand that some people cash checks from business income and record it as personal income. Other business owners inflate business expenses or just invent an “expense” to lower taxable income. Sometimes personal expenses are claimed to be business expenses.
Jagella
Everything in the above paragraph is cheating on your taxes. Those that cheat to a certain level get tax-free room and board provided by the government. A high number of those include doctors, lawyers, and probably design service business professionals.




A more legal strategy is to make purchases for your business prior to officially setting up your business. If you're still an salaried employee you may be able to get higher tax deductions.
Jagella
Purchases prior to officially setting up your business are NOT deductible personally (1040), however, the business entity, when started, can still deduct most, but not all, such expenses upto $5,000 as startup expenses with the balance over $5,000 written off over 15 years. Not a very good strategy.




Other strategies include bartering which is an activity that the IRS finds hard to detect, employing family members to get a tax-deductible business expense, incorporating, and you might even try buying a condominium and rent it back to your business as office space. Paying the rent is a legitimate business expense, and the rent money you collect as owner of the condominium can be mostly offset as tax deductible expense of investing in business property.
Jagella
Most of what you say in the above paragraph is not true or the tax effect you suggest is worse than what you think is the benefit.



Aren't you glad that the tax code is geared toward those of us who can afford to exploit it? :D

Jagella

You have no idea how much trouble you can expect from the tax collector. And having practiced as a tax professional for more than 40 years I can assure you that the tax code is not geared toward you unless you consider it a benefit that it can put you in prison.

Basically your strategies posted here are unrealistic and ridiculous.

orion_joel
12-30-2008, 10:19 PM
I really agree with Steve here, Getting in early is the absolute key. If you dont get in early then you really do leave yourself open to literally not being able to make the things happen in the time frame that they need to.

Evan
12-30-2008, 11:31 PM
Of course illegal practices would be "effective" at lowering your taxes. But these practices are NOT legal and do give you free room & board at, as said in Office Space, "a federal pound me in the ass prison."



It is also worth noting that if your company shows a constant loss for a number of years, this raises a red flag and you will be scheduled for an audit...
Generally after three years of showing a loss, the IRS will audit your "business". It's not that it'll be disclaimed, but they're going to try to classify your business as a hobby. Hobby expenses can only offset hobby income, and no loss can be claimed. And hobby expenses need to be claimed on Schedule A, subject to the 2% floor (must exceed 2% of your AGI). That means if you claim the standard deduction, as many do, you get no deduction for expenses.

There are dozens of way to reduce your taxes legally, but it does require planning. If you purchased a ton of new assets for the business, perhaps you can claim a Section 179 deduction and "depreciate" the asset quicker. (Copiers, printers, etc. also fall in this category). But that strategy is good THIS year, not NEXT year (because you wouldn't have that large deduction).

For a service-based business, if you use your home, the home office deduction should be investigated if you don't take it. But as with anything, you should discuss this with your tax professional. There is no set cookie-cutter tax reduction strategy that works for everyone. Whether you're a Schedule C filer, or 1065, 1120, or 1120S can have a great impact on what you can and can't do, and to what extent.

OldJack
12-31-2008, 10:26 AM
For a service-based business, if you use your home, the home office deduction should be investigated if you don't take it. But as with anything, you should discuss this with your tax professional.

Many are not aware that the 2008 tax legislation has changed the effect that taking a office in the home deduction has on their sale of the home in later years.

Prior law recaptured the amount of "depreciation" allowed or allowable as long-term capital gain with any additional gain being non-taxable since the home qualified as a personal residence.

Example before 2008 tax law: You claimed 25% of your home space as your office and you have taken $5,000 in depreciation deductions. You sell your residence with the office in the home for $300,000 with a gain of $100,000. In the past $5,000 of the gain is taxable as a long-term capital gain on form 1040 Sch-D with $95,000 as not taxable.

The 2008 tax law now treats the sale of the residence as part business property and part personal residence with the business portion subject to income tax with only the personal residence portion as non-taxable.

Example after 2008 tax law: You claimed 25% of your home space as your office and you have taken $5,000 in depreciation deductions. You sell your residence with the office in the home for $300,000 with a gain of $100,000. Now under the 2008 law you have the $5,000 taxable as a long-term capital gain but 25% of the sale of the residence is a sale of a business asset. Therefore 25% of the gain $100,000 or $25,000 is taxable reported on form 4797 attached to your 1040 tax return.

As a result of the tax law change, in most cases, for the year 2009 and forward, it is not wise to claim an office in the home deduction. Since the office has to meet strict requirements in order to take the deduction it is easy to disqualify your office and therefore not have to claim it on your future tax returns. In most cases the office in the home deduction saved only a minor amount of tax for the taxpayer anyway.

Edit Correction/clarification: The law is not clear if it applies to an office-in-the-home where the office was established after it qualified as a qualified residence for at least 2 years. Gain appears to be excludable after the 2 year residence requirement. Where the problem is the business use may be considered as a "period of nonqualified use" before the home qualifies as a residence when the gain can be excluded. If the office is not under the same roof as the residence (ie: the separate garage or structure on the residence land) it clearly is taxable on the gain.

Jagella
12-31-2008, 01:14 PM
Hi Jack:


Your best input would be from a qualified tax professional that can examine your specific business and offer professional advice.

I plan to meet with my accountant in the next month or so. Taxes will be on the agenda.


Those that cheat to a certain level get tax-free room and board provided by the government. A high number of those include doctors, lawyers, and probably design service business professionals.

I'm sorry to hear that some designers often cheat on their taxes. I will not.


Most of what you say in the above paragraph is not true or the tax effect you suggest is worse than what you think is the benefit.

I spoke to an IRS representative this morning on the phone about some of the issues I raised. He explained that he's not an expert on tax-reduction strategies, but he knows the tax laws, of course. He told me that everything I posted is legal.

By the way, I found this information in The Business Side of Creativity (http://www.amazon.com/Business-Side-Creativity-Complete-Communications/dp/039373207X/ref=sr_1_2?ie=UTF8&qid=1230747186&sr=1-2) by Cameron S. Foote. My school, The Art Institute of Pittsburgh, recommended this book to design students. With all due respect, why should I believe you rather than believe Foote?


You have no idea how much trouble you can expect from the tax collector.

Oh, but I do! I'm very careful to go by the book although I see no harm in considering unorthodox strategies to reduce taxes. If those strategies are illegal or ineffective, I'll make sure I know before I try any of them. I think that's prudent.


Basically your strategies posted here are unrealistic and ridiculous.

Considering all the variables involved in tax returns, one way to find out which strategy is best is to try preparing two or more returns to compare the tax liability of each strategy. Only some investigation under the guidance of a qualified tax professional can establish what is “unrealistic and ridiculous” and what isn't.

Thanks for the input.

Jagella

OldJack
12-31-2008, 02:12 PM
Hi Jack:
I spoke to an IRS representative this morning on the phone about some of the issues I raised. He explained that he's not an expert on tax-reduction strategies, but he knows the tax laws, of course. He told me that everything I posted is legal.

It is a fact that a annual survey is conducted on the accuracy of the IRS answers given on the telephone and of course it varies a little each year. The last I remember was that the IRS answers on the telephone was about 50-50. That is also about the correct answer percent you will get from a total stranger met on the street. This should not be a surprise since most everyone considers themselves as some kind of a tax expert.



With all due respect, why should I believe you rather than believe Foote?

I don't know of Mr. Foote and qualification or his publication. You should not believe anything you read on the internet or on a forum here since you really do not know if I am qualified or not. However, you should question your thinking when someone that appears to maybe be qualified tells you something different than your opinion. The fact here is that I am a CPA with 40+ years of tax experience arguing with IRS agents, but you really do not know if that is true since I will not disclose my name due to legal liability insurance. Therefore, you should consider my 2¢ for what it is worth to you.




Oh, but I do! I'm very careful to go by the book although I see no harm in considering unorthodox strategies to reduce taxes.


When it comes to interpretation of the tax laws there are what we refer to as "gray areas", meaning the law is not quite clear so we have to apply the law on the facts and circumstances of the particular taxpayer. I would not consider the words "unorthodox strategies" to apply to anything to do with tax law. What you do is either legal, maybe legal (gray area), or illegal. Gray area deductions must have "substantial authority" or the taxpayer is subject to substantial penalties. Substantial authority is defined in IRS Regulation 1.6662-4(d) if you are interested.

You mentioned "I understand that some people cash checks from business income and record it as personal income." I expect you would classify that as a unorthodox strategy. True, for a proprietorship business, that can be done legally but it does not change the total tax that is due since the income is still subject to self-employment tax of 15% plus income tax. Such income on the 1040 must be reported on 1040 Sch-C, subject to self-employment tax and income tax, the same reporting as for a proprietorship business. If the business entity is taxed as a S-corp it actually costs more tax since if reported on the 1120S corporate tax return as profit it would likely not be subject to the 15% self-employment tax.

With regard to unorthodox strategies that might result in a penalty:
---
1. Imposition of accuracy-related penalty - 20% of underpayment amount plus interest. code sec. 6662

2. Accuracy-related penalty with respect to "reportable transactions - 30% of understatement amount for "undisclosed listed transactions" 20% for all others plus interest. code sec. 6662A

3. Fraud - 75% of underpayment attributable to fraud plus interest. code sec. 6663

4. Frivolous or incomplete return - $5,000 regardless of actual tax liability. code sec. 6702

5. Willful failure to evade or defeat tax - Felony - up to $100,000 fine, 5 years in prison or both. $500,000 fine if a corporation.

6. Many others type penalties for just about anything you do that is not according to the tax laws.
---


How unorthodox does a taxpayer want to get with saving a few dollars of tax? That of course is up to each taxpayer.

SteveC
12-31-2008, 06:46 PM
The simple truth is that you need to seek independant professional advice, go visit your accountant and fill them in with your specific requirements and they can then advise you.

You can argue as much as you like, go see the professional you trust and pay to look after you in regard to taxes and such like... and make sure you have a good accountant, the advice they give can save you thousands.... hence everyone I think saying seek professional advice.

Evan
12-31-2008, 07:53 PM
Many are not aware that the 2008 tax legislation has changed the effect that taking a office in the home deduction has on their sale of the home in later years.

Yes, I'm aware of the change as I had looked up this change earlier in the year. Again, it's a short-term solution (the deduction) and depends on what the taxpayers goal is. Some won't mind, but there are consequences.

Of course we're optimistic and assuming that people will have GAINS when they sell their homes. Most still do, except not many new homeowners.

Like everything with taxes, it requires ample planning.

Evan
12-31-2008, 07:58 PM
True, for a proprietorship business, that can be done legally but it does not change the total tax that is due since the income is still subject to self-employment tax of 15% plus income tax. Such income on the 1040 must be reported on 1040 Sch-C, subject to self-employment tax and income tax, the same reporting as for a proprietorship business. If the business entity is taxed as a S-corp it actually costs more tax since if reported on the 1120S corporate tax return as profit it would likely not be subject to the 15% self-employment tax.

I believe you meant partnership?

In any case, this is very true.

OldJack
12-31-2008, 10:16 PM
I believe you meant partnership?

In any case, this is very true.

Nope... I meant a proprietorship (self-employed business) which reports their business on form 1040 Sch-C. If the taxpayer deposits a proprietorship business income as personal income it is self-employment income that still has to be reported on a 1040 Sch-C. Therefore the tax effect is the same if the income is reported on one Sch-C (business entity) or two Sch-C forms (business entity & self-employed individual). I guess the way I said it was not clear. In other words which pocket the cash went into is irrelevant as it still went into the individual's pocket and has the same tax characteristics of self-employment income.

As you point out a partnership entity results in the same tax also. However, as you know, if the entity is a S-corp the taxpayer is actually paying 15% self-employment tax on the 1040 Sch-C that might not have to be taxed if the income is reported as profit on the S-corp return.

However, if the entity is a C-corp it could save taxes in certain situations, but it would be strictly illegal. In any case its a dumb idea.

OldJack
12-31-2008, 10:30 PM
Yes, I'm aware of the change as I had looked up this change earlier in the year.

I would like to clarify my rambling on the office-in-the-home deduction. If the office is under the same roof as the residence and the residence was established before the office in the home, then the treatment of the sale as partly being a business sale is not applicable. In such case the tax treatment is the same as before the law inthat the depreciation taxable if their is gain. There is a specific exclusion in the code for that case.

What the new rule is after is taxpayers using the building for business uses and then establishing it as a residence, therefore claiming the gain is excluded under code sec. 121 residence exclusion.

Evan
01-01-2009, 12:48 AM
Thanks for the clarification. As with any law Congress makes and affects taxation (and the IRS), you can always expect confusion. :)

Jagella
01-01-2009, 11:24 PM
The last I remember was that the IRS answers on the telephone was about 50-50. That is also about the correct answer percent you will get from a total stranger met on the street.

What is the percentage of accurate tax information I can expect from an anonymous individual on an Internet forum? Just kidding. Seriously, the IRS should shape up if their information via phone is that poor.

Jagella

Evan
01-02-2009, 12:31 AM
What is the percentage of accurate tax information I can expect from an anonymous individual on an Internet forum? Just kidding. Seriously, the IRS should shape up if their information via phone is that poor.

Most accountants and tax professionals usually know more than the individuals answering the questions on the IRS phones. It's not that they're incompetent, but sometimes misinformed and have no practical application of what they're telling you.

And for what it's worth, I rarely question Jack's contributions. He is accurate to the extent the situation actually applies to you based on the information provided. Though I only question why he continues to practice after so many years! I guess the mind is the first thing to go!!! :D

Jagella
01-02-2009, 09:57 AM
Most accountants and tax professionals usually know more than the individuals answering the questions on the IRS phones. It's not that they're incompetent, but sometimes misinformed and have no practical application of what they're telling you.

And for what it's worth, I rarely question Jack's contributions. He is accurate to the extent the situation actually applies to you based on the information provided. Though I only question why he continues to practice after so many years! I guess the mind is the first thing to go!!! :D

I used to work for H&R Block, and I only lasted about four weeks. Taxes aren't so bad if I prepare my own, but preparing them for anybody who walks into the office is another matter entirely. So yes, I can vouch for the “mind going” as a result of trying to understand the tax code. Does anybody really understand it? I think the incoherency of the tax code is exactly why we're debating these topics on this thread.

Jagella

OldJack
01-02-2009, 12:31 PM
Though I only question why he continues to practice after so many years! I guess the mind is the first thing to go!!! :D

My mind is just fine thank you and the rest of my health is great! I had intended to retire in the winter of 2008 and not do another tax season. However, the wife and I are having a new home built in the town where my grandchildren live and it is not ready. I expect the house to be finished after this tax season and I will move sometime this next summer. But, I still plan to do a few tax returns and corporate work in my new office in the home. The only reason I am retiring is that I am to busy to work. :)

Evan
01-02-2009, 10:54 PM
Phew! That's a relief, Jack. And a good attitude about retirement too.

One day I'll be there.