Business or Hobby?

Credit Score Ingredients

When you incorrectly claim your favorite hobby as a business, it’s like waving a red flag that says “Audit Me!” to the IRS. However, there are tax benefits if you can correctly categorize your activity as a business.

Why does hobby versus business activity matter?

Chiefly, you’re allowed to reduce your taxable income by the amount of your qualified business expenses, even if your business activity results in a loss.

On the other hand, you cannot deduct losses from hobby activities. Hobby expenses are treated as miscellaneous itemized deductions and don’t reduce taxable income until they (and other miscellaneous expenses) surpass 2 percent of your adjusted gross income.

Here are some tips to determine whether you can define your activity as a business.

BUSINESS versus HOBBY
You have a reasonable expectation of making a profit. Profit Motive You may sell occasionally, but making money is not your main goal.
You invest significant personal time and effort. You depend on the resulting income. Effort and Income It’s something you do in your free time; you make the bulk of your money elsewhere.
Your expenses are ordinary and necessary to run your business. Reasonable Expenses Your expenses are driven by your personal preferences and not strictly necessary.
You have a track record in this industry, and/or a history of making profits. Background You don’t have professional training in the field and have rarely or never turned a profit.
You have multiple customers or professional clients. Customers You have few customers, mainly relatives and friends.
You keep professional records, including a separate checkbook and balance sheet; you have business cards, stationery and a branded business website. Professionalism You don’t keep strict professional records of your activities; you don’t have a formal business website or business cards.

The IRS will consider all these factors to make a broad determination whether you operate your activity in a businesslike manner. If you need help ensuring you meet these criteria, reach out to schedule an appointment.

 

Overtime Rules Go Into Overtime

Time Clock

The fate of a Labor Department rule extending mandatory overtime pay to workers by doubling the eligible salary cap is uncertain under the new presidential administration.

The rule introduced by the Labor Department under the direction of former President Barack Obama increases the salary cap for workers eligible to receive mandatory overtime to $47,476. It extends mandatory overtime, or time-and-a-half pay, to workers primarily in managerial or administrative roles in the retail, restaurant, and nonprofit industries.

Opponents of the rule won a court injunction blocking it in November 2016. The case may be abandoned altogether depending on the priorities set by President Donald Trump’s appointee to lead the Labor Department. Andrew Puzder, chief executive of fast food corporation CKE Restaurants Holdings Inc. (owner of Hardee’s and Carl’s Jr.) is undergoing Senate confirmation for the role. Until the case is resolved, the previous salary cap of $23,660 remains in place.

 

Save

Save

Create your cash flow snapshot

Identify your challenges. See if you have months where more cash is going out than is coming into your bank account. This is often when large bills are due. Try to balance these known high-expense months out over the year if at all possible. Common causes are:

Check The holidays
Check Property tax payments
Check Car and homeowners insurance
Check Annual income tax payments
Check Vacations
Bullet Item Build a reserve. If you know there are challenging months, project how much additional cash you will need and begin to save for this reserve in positive cash months.
Bullet Item Cut back on annuities. See what monthly expense drivers are in your life. Can any of them be reduced? Can you live with fewer cell phone add-ons? How about cutting costs in your cable bill? Is it time for an insurance review?
Bullet Item Shop your current services. Some of your larger bills may create an opportunity for savings. This is especially true with homeowners and car insurance.
Bullet Item Don’t confuse savings with cash flow. Think of your savings as the accumulation of positive cash flows from prior months. A high savings balance can often mask a monthly cash flow problem where more is going out than is coming in over a period of time.
Bullet Item Create savings “expense” to add to cash flow. Consider adding a “bill to yourself” in your cash outflows. This money saved is a simple technique to create positive cash flow each month to build an emergency reserve.

 

The Chances of Being Audited

2015 audit statistics show continued changes

What are the Chances?

Every year the IRS publishes the statistics on the number of tax returns they are examining. Provided here are the last three years of published information and a look back to 2008 to see any trends:

Percent of Individual Tax Returns Audited

Fiscal Year Year 2015 2014 2013 2008
All Individual Tax Returns 0.84% 0.86% 0.96% 1.00 %
No Income (AGI) 3.78% 5.26% 6.04% 2.15%
Income under $25,000 1.01% .93% 1.00% .90%
$25,000 – 50,000 .50% .54% .62% .72%
$50,000 – 75,000 .47% .53% .60% .69%
$75,000 – 100,000 .49% .52% .58% .69%
$100,000 – 200,000 .64% .65% .77% .98%
$200,000 – 500,000 1.54% 1.75% 2.06% 1.92%
$500,000 – $1 million 3.81% 3.62% 3.79% 2.98%
$1 million – $5 million 8.42% 6.21% 9.02% 4.02%
$5 million – 10 million 19.44% 10.53% 15.98% 6.47%
$10 million and over 34.69% 16.22% 24.16% 9.77%
Note: These audit rates are stated as a percent of total tax returns in each Adjusted Gross Income (AGI) class as claimed on individual tax returns. In general the examinations are for tax returns filed in the previous calendar year.

Source: IRS Data Books

Observations:

Point Overall, you have less than 1 out of 100 chance of being selected for an audit. The .84% audit rate is down .02% versus 2014.
Point The IRS is continuing its focus on returns with no AGI or negative income. This group’s 3.78% audit rate is down versus last year, but is still significantly higher than the 2.15% audit rate in 2008.
Point The IRS continues its focus on who pays the income tax. Those with incomes over $500,000 continue to have audit rates significantly higher than in 2008.
Point Over 1/3 of those with incomes over $10 million were faced with an audit.

Having good records
Your best defense in case of an audit is retaining adequate records for as long as you need them. This includes retaining copies of original tax returns and any supporting documentation. Please keep all receipts, statements and cancelled checks that support any tax return entry. Also retain legal documents, confirmation of asset purchases, asset sales, real estate transactions, mileage logs, and informational tax forms. Remember the IRS can audit your tax return for three years after the later of the filing date or when you filed your tax return. This time-frame is six years if your income is understated by more than 25%. Include any state record retention requirements as you review when it is safe to destroy old records. This can add one to two years to your recordkeeping requirements

New Overtime Rules

Timeclock

Employer and employee alert

On May 18, 2016 President Obama and Labor Secretary Perez announced new Department of Labor overtime regulations that go into place December 1, 2016. The Federal Labor Standards Act (FLSA) has information everyone needs to know to comply with these new rules.

Watch icon

Any worker making $47,476 or less must be paid overtime for hours worked in excess of 40 in a given week. This is true whether the employee receives a salary or hourly pay. The overtime rate must be at least time and one-half.
Watch icon Up to 10% of the compensation amount can be in the form of nondiscretionary bonuses or incentives.
Watch icon Highly compensated employees (HCE) is now defined as $134,004 or higher. The old rate was $100,000. Those above these income levels are exempt from the overtime rules as long as a minimal duties test is met.
Watch icon The new rule is effective December 1, 2016
Watch icon The wage amount will automatically reset every three years. The next change will be January 1, 2020.
Watch icon Actual implementation documentation has not been published in the Federal Register. Final regulations could still change slightly.

What this means to you

Watch icon There will be change. Any salaried employee who makes less than the $47,476 amount will see a change. It could take any of the following forms:

Point move from salaried employee to hourly employee
Point a raise to $47,476 or more
Point move from a flexible work-week to a scheduled work-week to comply with a strict 40 hour work week
Point increase in the tracking of hours
Watch icon Flex hours a thing of the past? Your work hours must now be tracked. Because of this, working from home and working flexible hours is more difficult. While the legal burden of reporting is placed on employers, employees will now need to track their work time.
Watch icon Required reporting. While the Department of Labor provides flexibility on how employers track hours, the standard of reporting will probably be tested through legal action. Here are some of the options per the Department of Labor.

Point Time clock. Have everyone track their hours by punching in and out.
Point Personal recordkeeping. Have each employee track their daily hours and report them to the employer each pay period on a timesheet.
Point Hard scheduling. Publish a schedule of hours for each employee. Record any deviation from the schedule and place the documentation with payroll records.

Note: Please refer the U.S. Department of Labor Fact Sheet #21 for a summary of the FLSA’s recordkeeping regulations.

Watch icon More than a raise. While many are touting this as a potential raise for more than 4 million employees, many believe two other objectives are in play. The first is to broaden employment. Employers may hire additional people to avoid the necessity of paying overtime. The second possible objective is to help re-establish a work and leisure balance.

No matter what the pundits say, the true impact of this change is unknown. The only certainty is that all employers now face additional administrative duties and potential legal action for non-compliance. This includes businesses, schools, and non-profit organizations. What is important at this point is to be aware of the upcoming change and plan for it.

IRS Revises Safe Harbor Repair Regulations

 

CopierIn November the IRS increased the amount your business can expense versus capitalize from $500 to $2,500. This change impacts businesses that do not publish applicable financial statements. The new rule takes effect starting in 2016, but there is audit protection for using this new limit in prior years.

What this means

This new rule is typically referred to as the safe harbor de minimis limit. Now small businesses may expense versus capitalize purchases of equipment that cost less than $2,500 and not have it challenged by the IRS. Without this change, small businesses would need to capitalize these purchases and then recapture the cost using depreciation over many years.

The irony is that with the recent extension of bonus depreciation through 2019, many small businesses would already expense many of these purchases. If this change could impact recent purchases of your business please ask for a review of your situation.

B-Corps; What are They?

Kickstarter, a popular crowdsource company that helps new inventors raise money to fund their creative projects, recently announced they are becoming a Benefit Corporation. While many of us may not know what this means, the move by Kickstarter is becoming more popular. Here is what you need to know.

Benefit Corporation defined

Per benefitcorp.net:

A Benefit Corporation voluntarily meets standards of corporate purpose, accountability, and transparency.

Bullet Purpose: Benefit Corporations have a corporate purpose to create a materially positive impact on society and the environment.
Bullet Accountability: Benefit Corporations are required to consider the impact of their decisions not only on shareholders but also on workers, community, and the environment.
Bullet Transparency: Benefit Corporations are required to make available to the public, except in Delaware, an annual benefit report that assesses their overall social and environmental performance against a third party standard.

Seedlings on coinsHow is this different?

When a traditional company takes actions that do not maximize their value, they can be vulnerable to owner lawsuits. To solve this problem, some states allow companies to legally organize themselves as B-Corps or Benefit Corporations. The B-Corp formation provides the company legal protection from shareholders while pursuing a social mission. This social mission is made public. Here are some examples;

Arrow Patagonia (outdoor gear): Commitment to the environment
Arrow King Arthur Flour (baked goods and flour): Sustainable living environment; ending child hunger
Arrow Ben and Jerry (ice cream): Advance new models of social justice that are sustainable and replicable
Arrow Kickstarter: Commitment to arts and culture
Click here to see the Benefit Corporation Charter of Kickstarter

Other things to note

Arrow Benefit Corporations can be private OR publicly owned.
Arrow The profits may or may not be as high as a typically organized corporation.
Arrow Benefit Corporations often give part of their profits to a worthy cause.

While an investment in a B-Corp may not be profit maximizing, you may feel a little better about where you put your money. As with any investment, please understand your risks and ask for help before investing.

Seven Simple Ideas to Help Your Small Business

If you are like millions of taxpayers trying to make a living running a small business, you know it is tough out there. Here are seven ideas to help your business survive and thrive.

Icon Understand your cash flow. One of the biggest causes of business failure is lack of understanding cash flow. At the end of the day, you need enough cash to pay your vendors and your employees. If you run a seasonal business you understand this challenge. The high season sales harvest needs to be ample enough to support you during the slow non-seasonal periods.

Recommendation: Create a 12-month rolling forecast of revenue and expenses to help understand your cash needs.
Icon Know your pressure points. When looking at your business, there are a few big items that drive your business success. Do you know the top four drivers of your financial success or failure? By staying focused on the key drivers of your business success will be easier to come by.

Recommendation: Look at last year’s tax return and identify the key financial drivers of your business. Do the same thing with your day-to-day operations and staffing.
Icon Inventory matters. If your business sells physical product, you need a good inventory management system. This “system” does not have to be complex, it just needs to help you keep control of your inventory. Cash turned into inventory that becomes stuck as inventory can create a major cash flow problem.

Recommendation: Develop an inventory system with periodic counts to ensure you do not have shrink (theft) issues and that can help identify when you need to take action to liquidate old inventory.
Icon Know your customers. Who are your current customers? Are there enough of them? Where can you get more of them? How loyal are they? Are they happy? A few, large customers can drive a business or create tremendous risk should they go to a competitor.

Recommendation: Know who your target audience is and then cater your business toward them and what they are looking for in your offerings.
Icon What is your point of difference? Once you know who your customer is (your target audience), understand why they buy your product or service. What makes you different from others selling a similar item?

Recommendation: If you don’t know what makes your business better than others, ask your key customers. They will tell you. Then take advantage of this information to generate new customers.
Icon Happy with your support team? Successful small business owners know they cannot do it all themselves. Do you have a good group of support professionals helping you? You will need accounting, tax, legal, insurance, and employment help along with your traditional suppliers.

Recommendation: Conduct an annual review of your resources, be prepared to review your suppliers and make improvements where necessary.

While libraries are filled with small business advisory books, sometimes focusing on a few basic ideas can help improve your business’ outlook. Please call if you wish to discuss your situation.

The Benefits of a Sole Proprietor

Tax Benefits of Being a Sole ProprietorIn the eyes of the IRS, if you are a sole proprietor you have an audit target on you. This is because the audit rates on those who have a schedule C (sole proprietor) in their 1040 tax return are much higher than those who don’t. In addition, sole proprietors generally have more personal legal liability as there is no legal entity between you and those who wish to sue your business. So does that mean there are no advantages to forming a small unincorporated business? Absolutely not. Here are some benefits of running your company as a sole proprietor.

Point You can hire your kids. One of the key benefits of being a sole proprietor is you can hire your kids and not have to pay Social Security and Medicare taxes for their work. While there are exceptions, this can save your small business over 7.65% on their wages.
Point Your kids benefit too. If the pay to your kids is less than $6,200, this income is not taxed to them at the federal level. Remember, their work must reflect actual activity and reasonable pay. Why not hire your kids to do copying, act as a receptionist, provide office clean up, advertising and other reasonable activities for your business?
Point Fewer tax forms and filings. Sole proprietors can add their business activity as a schedule with their 1040 tax return. Sub chapter S corporations, C corporations, and partnerships must file separate tax returns, which make compliance a lot more complicated. It is also harder to close these entities should things not go as planned.
Point More control of revenue and expense. As a sole proprietor, you often have more control over the taxable income of your small business. You can determine the timing of your business expenses to help manage your annual taxable income. The same is often true with booking your income.
Point Hire your spouse. If handled correctly, a spouse hired as an employee can work to your advantage as a sole proprietor. As long as the spouse is truly an employee of the business, the sole proprietor can benefit as a member of their employee’s (spouse’s) family benefits. This can include potential medical expense reimbursements.

As always, should you have any questions or concerns regarding your situation please feel free to call.

Missing the Flow-through Deadline

March 17th

The penalty that does not fit the crime
Please remember March 17th is the due date for filing Sub S Corporation tax returns that have a year-end of December 31st. While the Form 1120S does not require making a tax payment, missing the due date could cost you plenty. This is despite the fact that late filing of the sub S tax return does not impact the receipt of the taxes due on April 15th.
Those that are getting this “gotcha” penalty are often sole proprietors and couples who have formed a Sub S Corporation to handle their small businesses. The penalty is calculated based on each partial month the return is late times each shareholder. So a return filed 17 days late with no tax due could cost a married couple with a small S-Corporation $350 to $400 in penalties!

Action to take

Point 1 If you have a Sub S Corporation, or other flow through entity, either file an extension or submit your tax return on time. Remember, an extension gives you six months to file and you do not owe the tax until your 1040 tax return due date (typically April 15th).
Point 2 Challenge the penalty. While you may not be successful, remember the US Treasury is still receiving the taxes owed to them on a timely basis
Point 3 Do not file your individual 1040 tax return until you have received all your K-1 tax forms from the flow-through entities you own (like tax returns from Sub S and Limited Liability Corporations).

As always, should you have any questions or concerns regarding your situation please feel free to call.