Is Your Business Considered a Hobby by the IRS?

Very frequently tax preparers are asked to provide clarification on IRS rules that they heard from a friend, neighbor or colleague. Usually some part of the statement is true; however, there is always more to the story or it may not apply to that person’s specific situation.  If you’ve heard the statement, “You can’t deduct a loss from business if it occurs more than three out of five years,” this is not the entire truth. Read more

Guidelines

A person that conducts an activity for profit is allowed to deduct the expenses that are ordinary and necessary in that industry. If the expenses exceed the income, the amount can offset other income such as wages, interest, or dividends. However, if your activity is a hobby, you cannot reduce your other income by the losses.

When your losses exceed the three-year rule, the burden of proof now shifts to the taxpayer to prove the activity is a for-profit business. Here are some factors to consider:

•  The manner that you carry on the activity and the expertise of the taxpayer in this industry
•  The time and effort spent in the activity
•  The taxpayer’s history and success in this industry
•  The elements of personal pleasure or recreation

Here are some ways to ensure your for-profit business is not considered as a hobby:

1. Keep thorough and professional books.

2. Use a separate business bank and credit card account(s).

3. Log any personal use on assets, such as a camera.

4. Research trends in similar businesses.

5. Obtain insurance, registrations, certifications, licenses needed for that type of industry.

6. Maintain a second phone listing for business.

7. Document evaluations of your operation to attempt to improve the business’s profitability.

8. Develop a written business plan and update it annually.

9. Keep a detailed calendar of your business activities.

Here’s an example: Joe had a business as a personal chef. This was not his primary way of earning income. He had a W-2 job with a local city. He did earn about $200 to 300 in income; however, his expenses were much more than that. Come to find out, he was hosting dinner parties at his home and wanting to write off the food, subscription to cooking magazines, and seeds for his home garden.

If you are in doubt, just imagine yourself in front of an auditor explaining your specific situation. If it “feels” like the story above, it may not fly with the auditor, but that does not mean it is not a true business. What you need to do is plan and strategize. What can you do today to prove that you are a for-profit business?

Know the rules and then step out in confidence. And, don’t get tax advice from a friend because it might not be the whole truth! Consult your tax preparer to confirm your specific situation qualifies.

Do You Spend Too Much Time on Email?

If you feel like you spend too much time on email, you’re not alone. Almost everyone feels the same way. That’s why it’s so important to learn how to be as productive as possible when it comes to handling email. Here are five tips to help you do just that. Read more

Automate your Emails

If you’re sending a lot of the same emails to clients, you may be able to add them to email list management software like Constant Contact or MailChimp. Then you can automate a series of emails using the autoresponder function.

Another way to automate your emails is to set up inbox rules so that certain emails are automatically filed into the folders you’ve set up.  For example, if you get a monthly email for a recurring bill payment, you could send it straight to your bills folder if you don’t want to read it. This will save time in the morning when you sort through the pile of email that’s sent overnight.

Set a Timer

Make a habit of checking your email only once or twice in the day. Plan those times on your calendar and set a timer to stop if you need to. This employs time batching, one of the most productive ideas in time management.  It’s unproductive to stop and read each email exactly as it comes into your box, so setting times restructures the way you work with email for the better.

Create Draft Email answers of your Most Frequently Asked Questions

Do you get a lot of the same questions over and over again in your email? Don’t start from scratch each time you craft an answer. Start with a draft of a previous answer, make it generic, and save it in your drafts folder.  When you get that question again, copy and paste the draft and customize it as necessary.

Repeat this for your top ten (or twenty) most-asked questions or emails that you send. You’ll shave minutes off each email reply from now on.

Learn the Email Software You’re Using

Sure, everyone pretty much knows how to send, reply to, and forward emails. Most even know how to add attachments. But what else do you know and use on a regular basis?

If you are tech-savvy, then simply spend some time reviewing your email settings and functions. There may be some you discover that will make your day.

If you don’t feel very comfortable with all things technical, then sign up for a formal course, preferably in person, where you have a real human teacher that can answer all your questions. It will be a day well spent.

Set up Folders

Folders, labels, or categories in your email software are all good ways to segment email so that it can be processed in a particular order. Your folders might be by priority, client, service type, or something else. In any case, it’s easier on your brain to answer all questions from one client or topic at a time than it is to ping-pong back and forth.

Use folders when you are complete with an email but want to save it for future reference. That way, your inbox will stay cleaner and emptier.

Use the Search Function

Using the search function liberally in your email software when you need to find an old email will help you save tons of time.

Get a new email Address if your Current Email Address is too Spammy

You may be losing the spam battle with email addresses that have been used for more than a few years or that have been hacked. If so, the best solution might just be to switch to a new email.

Choose a good email address in the first place by staying away from email addresses that hackers can guess, like webmaster@yourdomain.com, sales@yourdomain.com, or info@yourdomain.com.  Instead use service@yourdomain.com or a version of your first and last names.

Try these email productivity tips to help you spend less time on email while still getting the job done.

Divorce: When It Comes to Taxes, Breaking Up Can Be Hard

divorceNot much is harder in life than going through a separation or divorce.  Figuring out how to handle your taxes before, during, and after a divorce can be a difficult challenge.  Read more

So, before you make big moves to separate or divorce, know the potential tax consequences, and take steps to protect yourself from further trauma and financial pain.

Here are seven tips on some of the most questioned tax topics for people who are divorced or divorcing:

When Are You Actually Divorced?

The IRS sees things differently about your divorce than you might, including the actual date of your divorce. If you get divorced this January 1st , you will have to file last year’s tax return as married.  The IRS sees your status on December 31st of the prior year as the story for the whole year.  On the contrary, if your divorce became final in December, you won’t be able to file as married even if that was your status for most of the year.

What Are Your Filing Options?

Even if you are legally still married as of the end of the year but divorce is impending, you may have some options in how to file for that year and can determine which route is most advantageous to both individuals. You could obviously file married filing jointly or married filing separately; however, in some cases, the head of household status – originally created for single taxpayers – might apply to you as well and could save you money.

To qualify as head of household, you have to be “considered unmarried” as of the end of the year (even if legally still married): you must have lived apart from your spouse for the last six months of the year, have paid over half the cost of keeping up your main residence (and it was the main home of your child(ren)), and be able to claim your child(ren) as your dependent(s) under the rules for children of divorced or separated parents. Also, you have to file a separate tax return from your spouse, even if you are still legally married.

The head of household route could significantly improve the overall tax outcome because of more favorable tax rates and higher thresholds for certain deduction items, so it’s worth checking into all of your filing options and determining what’s best for your particular situation.

Watch Out for Capital Gains Tax on the House

You don’t have to pay income taxes on assets that are transferred during a divorce. But keep in mind that if you do get the house in the settlement but want to sell, you will be subject to capital gains tax on the sale as a single person.

Normally, a married couple doesn’t have to pay taxes on a gain of up to $500,000 on their primary residence. If you are single, you can only exempt half of that. So if your house sells for more than $250,000 over what you and your former spouse paid for it, you will owe taxes, and the rate will depend on your income bracket.

Your Kids Aren’t Your Dependents…Unless the Court Order Says So

Custody agreements are often quite creative.  The arrangements are varied compared to the old days, when mothers typically got custody of the kids.  Now, custody is often shared, and the right to claim kids as dependents must be stated in the decree.

Generally, you can claim the kids as dependents only if you were designated to do so by your separation agreement or divorce decree. When there is no such agreement or order, or when joint custody applies, the custodial parent is considered to be the parent who has physical custody of the child for most of the year.

What happens when you share custody equally?  You will need to decide who claims the child, as you both can’t claim him/her as a dependent.  If there is more than one child, couples will often split the dependency of each child between the two parents. If you have two children, the mother can take one and the father can take the other as dependents.

Child Support Is Never Deductible

While alimony is considered a taxable event, child support is always non-taxable.  This basically means that it doesn’t affect your taxes in any way.  It is troublesome for some who are making large child support payments to understand that there is no tax break.  Likewise, the recipient of the child support payments does not have to report them as income.

It can be tempting for some to try to classify child support as alimony to get a tax deduction.  This is never a good idea and can get you in a lot of financial trouble later.  Remember, no matter how much you have to pay or for how long, you can’t deduct child support!

Alimony Affects Both Your Taxes

In 2017, individuals paying alimony get a lower tax bill because they can deduct it even if they don’t itemize.  The recipient must report the alimony as income, thereby increasing his or her tax bill.  What’s more, you most definitely need a written separation or divorce decree stating that alimony payments are not child support.  No written order means no tax break.

Couples who are facing extended divorce proceedings due to finances, custody battles or state laws need to be sure that support during long periods of separation is clearly defined.  If you pay the bills for your spouse while separated, it cannot be deducted as alimony without a written agreement.

The Tax Cuts and Jobs Act of 2017 changes the alimony rule.  For divorce agreements entered into after December 31, 2018 or existing agreements modified after that date that specifically include this amendment in the modification, alimony is no longer deductible by the payer and is not income to the recipient.

Be Aware of Community Property Rules

If you live in a state subject to community property rules (nine states total) and you file separate returns while still technically married (whether as Married Filing Separately or Head of Household), you will be required to report 50 percent of all income generated by community assets during the time you were married. This includes wage income and any income earned from community property (property acquired during marriage), like rental and investment income.

This can have multiple implications, and the most advantageous filing status (joint or separate) can vary largely depending on how long you were married, assets brought into the marriage vs. those acquired while married, income earned by one spouse vs. another, etc. Furthermore, these community property/allocation rules are handled differently in each state , and the interpretation can become somewhat complex.

It’s important to know what income/deduction/credit items should be split 50/50 on the return.  For example, while sole proprietorship income of one spouse is community income that should be split, the self-employment tax on that income is imposed solely on the spouse carrying on the business.

Because of these complexities, it is important to understand the rules of your state and seek guidance in navigating them. If you need help filing your personal or business taxes, reach out to us at P.T. Anderson Accounting.

How to Read Your Income Statement

income statementThe income statement of any business is probably the most important report of all.  It is a snapshot of the financial performance of your business over a period of time, such as a month or year.  You might also hear it called the Profit and Loss Statement, or P&L.  Read more

The income statement can give you all kinds of insights as to whether you are bringing in enough sales, if your prices are generating enough profit, and how your expenses are running.  Let’s take a look at the report, step by step.

Revenue

The report starts by listing the revenue for the period of time covered.  Revenue includes all sources of income, including sales from operations, interest and investment income, revenue from insurance claims, sales from assets or other parts of the business, and any other source of revenue. In most small businesses, sales will be the largest part of the revenue, if not all of it. In some countries, the term used for sales is turnover.

If you sell more than one item or have more than one location, it might be a good idea to be able to view the sales detail from these categories.  This may or may not be on your income statement depending on how formal it is, but you should be able to get a drill down report on your sales detail.

Look for exceptions to what you expect to see.  There can be some decisions you can make and actions you can take from the insights you discover.

Cost of Goods Sold

This section of the income statement includes costs you incur directly on items you sell. If you maintain an inventory, it’s the cost you paid for the inventory items that you sold during the period. If your business is a manufacturer, cost of goods sold, or COGS, will include costs of materials and labor to produce the items.

COGS will typically be zero, if you own a service business.  As a service business, you may incur direct costs when providing services, and these costs can be booked in a variety of expense accounts, including supplies.

Gross Profit

Some income statement formats will include a gross profit number which is sales minus cost of goods sold.  This number is important for businesses with inventory.

Expenses

The expenses section of the income statement is the longest part. It includes all of the expenses you incurred in your business, including advertising and marketing, rent, telephone, and utilities, office supplies and meeting expenses, travel, meals, and entertainment, payroll and payroll taxes, and several more.

You might also hear the term overhead. Overhead is a subset of expenses that have to be met whether you sell zero items or millions. They include items like rent and utilities, management payroll, and office supplies.

To review your expenses, check line by line to see if anything looks out of sorts, and take the appropriate action.

Net Profit or Loss

The final number on your income statement represents whether you made or lost money in the period the report covers. The formula is simple: revenue less COGS less expenses equals net profit or loss.

Net profit/loss can go by many names, depending on the size of your business and your accountant’s vernacular. You may also see EBITDA: Earnings before interest, taxes, depreciation, and amortization. Earnings is another word for net profit.

Perspective

It’s a good idea to compare your income statement numbers to other periods in your business. Common comparisons include last period, last several periods, and same period last year.

It’s also a great idea to have a budget that sets goals for your income statement numbers. Then you can compare budget to actual numbers and take action on the variances.

If your business falls into a standard type of business, you may also be able to see how it is doing compared to others in your industry.  This is called benchmarking, and the income statement is a very common format that’s used in benchmarking.

Do spend some time each period reviewing your business’s income statement. It can help you make a faster course correction in your business so you can be even more successful than you already are.

If you need help preparing and understanding your financial statements, contact us at P.T.A and let us help your business.

New Tax Brackets in 2018

new tax bracketsThe 2017 Tax Cuts and Jobs Act revised some foundational deductions, exemptions, and tax brackets for the 2018 tax year. Here’s a rundown of what’s changed in that area for individuals:  Read more

Exemption

On your 2017 1040 tax return, you likely received an exemption of $4,050 per person.  Check line 42 of your own return. In 2018, this exemption is discontinued, but you won’t really lose out because the standard deduction has increased to compensate for this elimination.

Standard Deduction

In 2017, your standard deduction was $6,350 per person in general and $9,350 for head of household.  In 2018, the standard deduction will increase to $12,000 per person and $18,000 for head of household filers.

Quite a few itemized deductions have been eliminated or capped for 2018, so more taxpayers will be using the standard deduction going forward.

Tax Brackets

There are seven tax rates or brackets, just like there were before, but the threshholds and rates have changed. The rates now range from 10 percent to 37 percent:

  1. 10 percent
  2. 12 percent
  3. 22 percent
  4. 24 percent
  5. 32 percent
  6. 35 percent
  7. 37 percent

Here are the details depending on your filing status:

 

Rate or Bracket Single Married Filing Joint Returns Head of Household
10 % $0 to $9,525 $0 to $19,050 $0 to $13,600
12 $9,526 to $38,700 $19,051 to $77,400 $13,601 to $51,800
22 $38,701 to $82,500 $77,401 to $165,000 $51,801 to $82,500
24 $82,501 to $157,500 $165,001 to $315,000 $82,501 to $157,500
32 $157,501 to $200,000 $315,001 to $400,000 $157,501 to $200,000
35 $200,001 to $500,000 $400,001 to $600,000 $200,001 to $500,000
37 over $500,000 over $600,000 over $500,000

 

The new withholding tables are posted here:

https://www.irs.gov/pub/irs-pdf/n1036.pdf

If you have questions about this or anything about the new law, please feel free to reach out to us at P.T. Anderson at any time.