Sunday, April 30, 2017

Perspective: What Frustrates Me Most About Start-Ups!

One of the services my firm offers is assistance in Entity Selection for start-ups. This is usually when we talk about various options available for the Incorporator and what type of entity would be the best fit for the start-up in terms of liability exposure, record-keeping and tax filing. This meeting usually results in setting up an entity, giving the incorporators guide-lines for record-keeping and help with choosing accounting software and set up, and so on, you get the drift? 

So off they go with an Entity tucked away neatly under their arm, and the title music plays-- you think? But no wait, here's where the music stops with an ugly, teeth-tingling screech: The Incorporator comes back at tax time and you look at all the bank statements, and you see the big thou-shalt-not: "Commingling The Books". 

What is this commingling you ask? 

Commingling happens when a business owner uses their business checking account to pay for both personal and business expenses. Personal expenses become subject to payroll taxes as compensation to the business owner. 

You see, the Internal Revenue Service says that "To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business."  As per Reg. § 1.6001-1, the business owner needs to keep "contemporaneous" records to prove income and expenses.

It is therefore imperative that there is separation between personal & business expenses. I cannot stress enough about the need to keep diligent records, this not only makes your tax filing less stress-full but also gives you information you need to keep your business up and running profitably. 

How should one clean up the commingling?

First thing to do is to find all the personal expenses. If you had many transactions in the year, this will take a long time but thoroughness is important. The Internal Revenue Service flags expenses like that spent on travel, hotel,meals, groceries, clothes, cosmetics, entertainment and such. Anything classified as "Miscellaneous" draws IRS attention too. 

Once all the personal transactions are found, one has to be sure everything is classified as accurately as possible. The cleanest way to do this is to book these expenses as compensation and pay payroll taxes on them. Payroll taxes come at a price, and the process takes time and is complicated, especially if one has to go back & amend payroll reports. Many small business owners tend to classify these as a personal loan which is to be re-paid within a short period of time. Some tend to reduce the Capital account without regard to capital gain issues or the basis the owner has in the business. Partnerships may classify these as guaranteed payments and pay tax on it. 

Loans even if to owners/ shareholders should have proper loan agreements with interest accrued/ paid; reduction of capital beyond the owner's contribution or a negative capital account on the books is a huge red-flag; and partnerships should have proper approvals in their operating agreement regarding guaranteed payments.

 As a small business owner myself (my tax practice), I face the challenge in drawing firm lines between work and life everyday. But this is a habit one should cultivate as we go about our daily lives because fixing matters in retrospect is always more difficult. It all starts with being meticulous about one's record-keeping and strict with not using business funds for personal use. 

Quoting one of my most favorite Jungle Book characters, Colonel Hathi, "Discipline! Discipline was the thing! Builds character, and all that sort of thing, you know". Discipline, my friend is the key to a smooth, and stream-lined business process. 

As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website, 

Sunday, April 16, 2017

Sticker Shock From The Tax You Owe: Read This!

Everywhere these days commercials are vying to get you to spend your big tax refunds on their products and services..oh yeah even that liposuction place! But you just finished preparing your taxes and you find out you OWE Uncle Sam big bucks. That is quite the sticker shock if you are short on cash or are unprepared.

There is one school of thought that it is okay owing at the end of the year as long as one does not pay penalties-- at least you did not have the government keep your money interest free! 

But if you don't like that line of thinking and owing money, here are some steps you can take to make life easier at tax time: 

1.  Check Your Withholding:   

Check the Forms W-4 you have filed with your employer to make sure you are having enough taxes taken out of your salary. The more taxes you need to be taken, the lower should your withholding number should be. It also matters if you put down if you are single or married. Many people get confused with the Form W-4--it lets you manage your cash flow from your paycheck. 

2. Paying In Quarterly If You Are A Freelancer: 

This is how I think most freelancers can reduce the pain of owing a lot at tax time or the uncertainty of not knowing how much they will pay. The freelancer has more options as far their write-offs go. They can take certain expenses such as mileage, home office, supplies etc and reduce their income. 

3.  Check if You Qualify For Contributions to IRA:

If you have the cash, and if your income limits permit, you have time until the deadline to contribute into a Traditional IRA for the previous tax year. You can contribute a maximum of $5,500 (with a catch-up of $1000 if you are over 50 years old) and defer some income from taxes. Plus if your income is within the qualifying limits, you will also earn a Retirement Credit. 

4. If You Are Married, play out the "Married Filing Separately" scenario

Almost all married couples benefit from filing jointly but it doesn't hurt to run a mock "Married Filing Separately" scenario to check if you could potentially reduce taxes. This is especially true of high-earners. Filing separately may put each of you in a lower income bracket and qualify you for some contributions and/ or deductions. Note: Do check if the state you live in is a community property state, rules here will be different for "married filing separate". 

5. Apply For An Extension: 

Okay so you are still in sticker shock, take a deep breath, apply for an extension. Get some time to figure out your finances and arrange for money. Send in as much as you can with the extension and check out the Internal Revenue Service's various resources for:

  • Installment / Payment Agreements: This can be done online or by filing Form 9465 with your tax return. You will qualify for this if you owe less than $50,000 as an individual or $25,000 as a business.
  • An Offer-In-Compromise: You can find out if there is a way to settle your debt for less than what you owe.  
  • Delay The Collection Process: The Internal Revenue Service may determine that you cannot pay your tax debt and delay action in collecting it. But penalties and interest keep accruing till the debt is paid off. 

These three suggestions above are all complicated methods of paying off your taxes and you will need professional assistance from an Enrolled Agent.


As always, read my disclaimer here. Please consult a qualified tax professional for your unique tax needs. More of my contact information is on my website,