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Tuesday, May 15, 2018

Saving for College

Custodial Accounts (UTMA/UGMA)

Assets in a custodial account belong to the minor. A custodian, usually an adult relative, controls the assets until the minor reaches the age set by state law (21 in most states).

Assets in a custodial account can be used to pay for education expenses for the minor.

Savings Bond Interest Exclusion

Exclusion Rules

Interest from qualified savings bonds redeemed by the taxpayer can be excluded from income if:
• The taxpayer paid qualified education expenses during the year for the taxpayer, spouse, or a dependent claimed on the taxpayer’s return.
• Filing status is not Married Filing Separate. If proceeds from the redemption (interest and principal) are more than adjusted qualified education expenses, only a percentage of the interest is excludable.
Example: Marty redeemed qualified bonds for $10,000, including accrued interest of $5,500. He paid $8,000 of qualified education expenses during the year. His excludable interest is:
$5,500 × $8,000 qualified expenses = $4,400 tax-free interest $10,000 redemption proceeds interest

Income Limit

The exclusion is limited by adjusted gross income. Check with your tax preparer or accountant Lancaster SC or accountant Waxhaw NC for income limitations.

Qualified Savings Bonds

• Series EE bonds issued after 1989 and Series I bonds.
• Issued to a person who was age 24 before the bond’s issue date. The issue date is the first day of the month in which the bond was purchased (for example, a bond purchased on May 25 has a May 1 issue date). The issue date is printed on the front of the bond.
• Issued in the name of the taxpayer and/or spouse. There can be no other co-owners, including the taxpayer’s child. The bond can have a pay-on-death (POD) beneficiary, including a child.

Qualified Education Expenses

• Tuition and fees required for enrollment or attendance at an eligible educational institution. Qualified expenses do not include courses involving sports, games, or hobbies, unless part of the student’s degree program.
• Contributions to a qualified tuition program.
• Contributions to a Coverdell education savings account.

Qualified Tuition Plans (529 Plans) & Educational Savings Accounts (ESAs)

QTP and ESA Tax Benefits

Contributions to a QTP or ESA are not deductible. Earnings accumulate tax free. Distributions are not taxable if less than the beneficiary’s adjusted qualified education expenses in the year of distribution. Contributors can contribute to both a QTP and an ESA in the same year for the same designated beneficiary.

Qualified Expenses

• Tuition, fees, books, supplies, and equipment required for enrollment or attendance of the designated beneficiary at an eligible institution.
• Expenses for special needs services of a beneficiary with special needs incurred in connection with enrollment or attendance.
• Room and board for students enrolled at least half time in a degree or certificate program. Expenses are limited to the room and board allowance included in the cost of attendance set by the school for financial aid purposes or the actual cost of campus housing, if greater.

Did You Know? Most colleges and universities set room and board allowances for students who live on campus, off campus, and with parents. Check the school’s financial aid website for costs of attendance.

For ESAs, the following additional expenses are allowed.
• Expenses for enrollment or attendance at any public, private, or religious school that provides K – 12 education as determined under state law.
– Tuition, fees, books, supplies and equipment, academic tutoring, special needs services.
– Room and board, uniforms, transportation, supplementary items and services, including extended day programs if required or provided by the school.
• Purchase of computer technology, equipment, or internet access and related services to be used by the beneficiary and family during elementary or secondary school years. Does not include computer software unless predominantly educational.
• Contributions to QTPs for the designated beneficiary.

Adjustments

Qualified expenses are reduced by:
• Tax-free assistance (scholarships, fellowships, grants, employer-provided assistance, veterans benefits, and any other nontaxable payments except gifts or inheritances).
• Amounts used to figure an education credit.



There are many events that occur during the year that can affect your tax situation. Tax return preparation involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please contact us in advance if you have questions about the tax effects of a transaction or event, including the following:
• Pension or IRA distributions.
• Significant change in income or deductions.
• Job change.
• Marriage.
• Attainment of age 59½ or 70½.
• Sale or purchase of a business.
• Sale or purchase of a residence or other real estate.
• Retirement.
• Notice from IRS or other revenue department.
• Divorce or separation.
• Self-employment.
• Charitable contributions of property in excess of $5,000.

This article contains general information for taxpayers and  should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information.

Tuesday, April 10, 2018

Business Entity Comparison Charts

Accounting and Recordkeeping - Fringe Benefits - Liability

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Organization and Ownership - Taxation of Profits and Losses

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Business accounting and tax preparation is a dreadful task for most Carolina business owners. Thankfully, in your time of need there is a professional you can trust to turn to for assistance. That professional is Franklin P. Sparkman, a certified public accountant in Charlotte NC.

Wednesday, March 7, 2018

Education Tax Benefits

If you pay tuition, fees, and other costs for attendance at an eligible educational institution for yourself, your spouse, or your dependent, you may be able to take advantage of one or more of the education tax benefits.


You can claim more than one education benefit in a tax year as long as you do not use the same expenses for more than one benefit.

Exception: Qualified expenses used to claim education benefits can also be used to eliminate the 10% penalty on premature IRA distributions.

You may claim only one of the following education tax benefits for the same student per year: tuition and fees deduction, American Opportunity Credit, or Lifetime Learning Credit.

Education Deductions

Deductions reduce the amount of income subject to income tax. Deductions for education expenses include:
• Tuition and fees deduction up to $4,000 from gross income. Income limitations apply.
• The provision for deducting tuition and fees expires for tax years after 2016.
• Student loan interest deduction up to $2,500 from gross income. Income limitations apply.
• Business deduction on Schedule C or F. You can deduct the cost of education related to the business or farm activity.
• Miscellaneous itemized deduction on Schedule A, subject to the 2% AGI limitation. You can deduct the unreimbursed cost of education required to keep your current job or maintain and improve skills needed for your job. You cannot deduct the cost of education that qualifies you for a new trade or business.

Education Tax Credits

Tax credits reduce the amount of income tax you may have to pay. Income limitations apply. The education credits are claimed on Form 8863, Education Credits (American Opportunity and Lifetime Learning Credits).
• American Opportunity Credit, $2,500 maximum per student per year.
• Lifetime Learning Credit, $2,000 maximum per tax return per year. Note: The Hope Credit applied to 2008 and earlier years. It was replaced by the more generous American Opportunity Credit for tax years after 2008.

Penalty-Free IRA Distributions

If you withdraw money from your IRA before you are age 59½, you are generally subject to a penalty of 10% of the distribution, in addition to any tax that may be due on the distribution.
• The 10% penalty does not apply to traditional IRA or Roth IRA withdrawals, if you use the money to pay qualified education expenses for yourself, spouse, or for any child or grandchild of yourself or your spouse.
• Qualified education expenses include tuition, fees, books, supplies, equipment, and special needs services required for enrollment or attendance at an eligible educational institution. Room and board for students enrolled at least half-time in a degree or certificate program may also qualify.
• Reduce qualified expenses by scholarships and other tax-free assistance the student receives, but not by gifts or inheritances.




Education Savings Plans

Contributions that you make to education savings plans are not deductible, but the earnings accumulate tax free. In addition, no tax will be owed on distributions if they are less than the beneficiary’s qualified education expenses. Qualified expenses are reduced by scholarships, other tax-free assistance, and amounts used to figure education credits.
• Qualified Tuition Programs (QTPs). States sponsor QTPs to allow prepayment of a student’s qualified higher education expenses. For information on a specific QTP, you need to contact the state agency or eligible educational institution that established and maintains it. Note: QTPs are also called 529 Plans because they are authorized under section 529 of the Internal Revenue Code.
• Coverdell Education Savings Accounts (ESAs). A Cover dell ESA can be used to pay a student’s eligible K-12 expenses, as well as higher education expenses. Coverdell ESA contributions are limited to $2,000 total per year for each beneficiary, no matter how many accounts have been established or how many people are contributing. Unless the beneficiary is a person with special needs, contributions to a Coverdell ESA must stop before the beneficiary reaches age 18 and the account balance must be distributed within 30 days after the beneficiary reaches age 30 (or dies, if earlier).

Exclusions From Gross Income

An exclusion from income means you don’t report the benefit you receive as income and you don’t pay tax on it, but you also can’t use that same tax-free benefit for a deduction or credit.
• You may exclude the part of scholarships, fellowships, and grants that you use for qualifying education expenses while you are a degree candidate.
• You may exclude up to $5,250 paid for you under a qualifying educational assistance plan. Additional amounts are included in your W-2 income, unless they are a working condition fringe benefit. A working condition fringe benefit is an amount that you could have deducted as an employee business expense, had you paid for it instead of your employer.
• If you cash in qualified U.S. Savings Bonds to pay for eligible education expenses for yourself, spouse, or your dependent, you may exclude the bond interest from income. Income limitations apply.


To learn more about our tax preparation services in Lancaster SC and Charlotte NC, please visit FPSparkmanCPA.com

This article contains general information for taxpayers and should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information.

Friday, February 16, 2018

Employee or Independent Contractor

Employee or Independent Contractor? In order for a business owner to know how to treat payments made to workers for services, he or she must first know the business relationship that exists between the business and the person performing the services. A worker’s status determines what is needed for tax preparation; what taxes are paid and who is responsible for reporting and paying those taxes. A worker performing services for a business is generally an employee or an independent contractor. If a worker is classified incorrectly, the IRS may assess penalties on the employer for nonpayment of certain taxes.


Penalties and Interest

When the IRS determines that a worker is actually an employee rather than an independent contractor, the employer is subject to penalties for failure to withhold and remit income, FICA (Social Security and Medicare) and FUTA (federal unemployment tax) taxes, interest on the underpaid amounts, and penalties for failure to file information returns. The state will also seek to collect workers’ compensation and unemployment compensation premiums for unreported wages.


Independent Contractor

An independent contractor is self-employed and is generally responsible for paying his or her own taxes through estimated tax payments. A business issues Form 1099-MISC, Miscellaneous Income, to any one independent contractor, subcontractor, freelancer, etc., to whom the business made $600 or more in payments over the course of the tax year. The business is not generally responsible for withholding income tax or FICA.


Employee

A worker treated as an employee will be issued Form W-2 for wages paid. The business hiring the worker is responsible for withholding income tax and FICA. The employer is also liable for FUTA and various state employment taxes. Also, the employee may be eligible for certain fringe benefits offered by the employer, such as health care.

Factors to Determine Worker Status

The general rules for classifying workers as independent contractors or common-law employees center on who has the right to control the details of how services are to be performed. The factors can be grouped into three categories.

1) Behavioral control. Factors that indicate a business has the right to control a worker’s behavior include the following.
Instructions that the business gives to the worker. Employers generally control when and where work is to be done, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, and what order or sequence to follow.
Training that the business gives to the worker. Employees may be trained to perform a service in a particular manner. Independent contractors generally use their own methods.

2) Financial control. Factors that indicate a business has the right to control the business aspects of a worker’s job include the following.
Extent of the worker’s unreimbursed business expenses. Independent contractors are more likely to incur expenses that are not reimbursed, such as fixed overhead costs that the worker incurs regardless of whether work is currently being performed.
Extent of the worker’s investment. Independent contractors often have significant investment in facilities used to perform services for someone else, such as maintaining a separate office or other business location.
Extent to which the worker makes his or her services available to the public. Independent contractors are generally free to offer their services to other businesses or consumers. They often advertise and maintain a visible business location.
Method of payment for services performed. Employees generally are guaranteed a regular wage and work for an hourly fee or a salary. Independent contractors are generally paid a flat fee for a specific job. Exceptions apply to some professions, such as accountants and lawyers who charge hourly fees for their services.
Extent to which the worker can make a profit. Independent contractors can make a profit or a loss.

3) Type of relationship between the parties. Factors that indicate the type of relationship include the following.
Written contracts that describe the relationship and intent between the worker and the business hiring the worker.
Employee-type benefits provided to worker. Employers often provide fringe benefits to employees, such as health insurance, pensions, and vacation pay.
Permanency of the relationship. Employer-employee relationships generally continue indefinitely.
Extent services performed by the worker are a key aspect of the business hiring the worker. A worker who is key to the success of a business is more likely to be controlled by the business, which indicates employee status. For example, an accounting firm hires an accountant to provide accounting services for clients. It is more likely that the accounting firm will present the accountant’s work as its own and would have the right to control or direct that work.


Incorrect Treatment of Employees as Independent Contractors

A worker who receives a 1099-MISC instead of a W-2 has two options.
1) Agree with the way the business has classified the worker, file Schedules C and SE, and pay self-employment tax on the earnings, or
2) File Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The IRS will then decide if the worker should have been treated as an employee, subject to income and FICA tax withholding. If the IRS agrees that the worker really is an employee, the employer will be liable for employment taxes. However, if the IRS determines that the worker is really an independent contractor, the worker will be liable for paying SE tax.

Example: Harold owns a restaurant and hires Jim, a gardener, to mow the lawn and weed the landscaping once a week. The contract states that Jim will arrive at the restaurant on Monday mornings, mow the lawn, pull weeds, and tend to the landscaping. In exchange, Harold agrees to pay Jim $50 for this service each week. Jim supplies his own lawnmower, weed eater, and hedge clippers. Jim decides what time he arrives and how long the job will take him. Harold does not supervise Jim in his tasks or dictate to him how they are to be done. Jim is an independent contractor.
 

Example: Jeffrey owns Jeffrey’s Gardening Service and employs three gardeners to perform services for his business. Jeffrey pays his gardeners a fixed wage and withholds taxes, FICA, and various benefits and remits those withholdings to the appropriate government agencies. In addition, Jeffrey provides his employees with the tools and equipment they need to perform their work, instructs his employees which jobs to go to, and supervises them while they are doing their work. Jeffrey’s workers are employees.


Contact Us

There are many events that occur during the year that can affect your tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please contact Franklin P Sparkman CPA in advance if you have questions about the tax effects of a transaction or event, including the following:
• Pension or IRA distributions.
• Significant change in income or deductions.
• Job change.
• Marriage.
• Attainment of age 59½ or 70½.
• Sale or purchase of a business.
• Sale or purchase of a residence or other real estate.
• Retirement.
• Notice from IRS or other revenue department.
• Divorce or separation.
• Self-employment.
• Charitable contributions of property in excess of $5,000.


This article contains general information for taxpayers and should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information.

Wednesday, January 17, 2018

Business Owners—Taking Money Out of a Business

When taking money out of a business, transactions must be carefully structured to avoid unwanted tax consequences or damage to the business entity. Business owners should follow the advice of a tax professional to make sure financial transactions are controlled and do not cause unanticipated taxation or other negative effects.

For example, a shareholder of a corporation can make a loan to the corporation, and subsequent repayments of principal are not taxable to the shareholder. This may seem straightforward. However, if the loan and repayments are not set up and processed properly, with specific documentation in place, the IRS can reclassify the funding as nondeductible capital contributions and classify the repayments as taxable dividends, resulting in unexpected taxation. A weak loan structure can also create a danger zone where a court can “pierce the corporate veil,” resulting in personal liability for the business owner. These negative effects can occur in several different situations.

Classifications
When a business owner provides funds to the business, it can be classified as one of the following transactions.
Capital contribution.
Loan to the corporation.
Repayment of a loan from the corporation.
Expense reimbursement.
Purchase.

On the other hand, when an individual takes funds from a business, the transaction can be classified as:
Taxable dividend or distribution of profits.
Nontaxable distribution.
Nontaxable expense reimbursement.
Taxable wages.
Loan to the shareholder.
Repayment of a loan from the shareholder.

Failure to tightly control the nature of the transactions can have negative effects on the business and the business owner.

Intermingling Funds
One of the most dangerous financial mistakes a business owner can make is to intermingle funds, such as paying personal expenses from the business checking account, or paying business expenses from the owner’s personal account. This can be done with the best of intentions with the business owner making adjustments in the books to separate the business and personal transactions, but the behavior can leave openings for the IRS or courts to question the integrity of the business entity or the transactions. Failure to maintain complete financial separation between a business and its owners is one of the major causes of tax and legal trouble for small businesses.

Sole Proprietorships
A sole proprietor is taxed on self-employment income without regard for activity in the business bank account. A sole proprietor should never pay himself or herself wages, dividends, or other distributions. A sole proprietor may take money out of the business bank account with no tax ramifications.

Taking Money Out

Wages
One way for a business owner to take money out of a corporation is through wages for services performed. Wages are appropriate only for C corporations and S corporations, not for sole proprietorships or partnerships. Owners are treated as employees, payroll taxes and income taxes are withheld, and the corporation issues Form W-2, Wage and Tax Statement, to the business owner after the beginning of the year.

“Reasonable Wages”
For C corporations and S corporations, there are incentives to skew wages one way or the other for purposes of tax savings. In a C corporation, wages are deductible by the corporation but dividends are not, creating incentive for a C corporation shareholder to inflate the wages for higher deductions. In an S corporation, wages are subject to payroll taxes but flow-through income is not, creating an incentive for artificially low wages. Both C corporations and S corporations are required by law to pay “reasonable wages,” which approximate wages that would be paid for similar levels of services in unrelated companies.

Guaranteed Payments
Guaranteed payments to partners are the partnership counterpart to corporate wages. One major difference is with guaranteed payments, there is no withholding for payroll taxes or income tax. These amounts are computed and paid on the partner’s individual Form 1040.

Dividends
Dividends are generally the means by which a C corporation distributes profits to shareholders. Amounts up to the C corporation’s “earnings and profits” are taxable to the shareholder. Although flow-through income from S corporations or partnerships are often called “dividends,” they are not treated as dividends under tax rules.

Flow-Through Income—S Corporations and Partnerships
Income from S corporations and partnerships flow through to the shareholder or partner’s individual tax return. Flow-through income is reported without regard for whether or when the income is distributed to the shareholder or partner. Distributions of cash to an S corporation shareholder or partner are not taxable to the individual until the person’s cost basis reaches zero.

One-Class-of-Stock Rule
An S corporation is allowed to have only one class of stock. If an S corporation does not make equal distributions to all shareholders, this rule may be violated and the S corporation status may be terminated. The oneclass-of-stock rule must be adhered to whenever making distributions from an S corporation’s bank account.

Loans
A corporation or partnership can receive loans from shareholders or partners, and on the other hand a corporation or partnership can make loans to shareholders or partners. There is generally no taxable event when a corporation or partnership repays a loan from a business owner, and no taxable event when a corporation or partnership makes a bona-fide loan to a shareholder or partner. However, failing to adhere to necessary formalities can put these transactions in danger, allowing the IRS to step in and reclassify the transactions, resulting in taxable income for the business owners.

Limited Liability Companies (LLCs)
Taxation of an LLC falls into either a default category, or the LLC makes an election on the manner of taxation. A single-owner LLC owned by an individual is considered a “disregarded entity” and is taxed as a sole proprietorship by default. If the LLC makes an election to be taxed as a corporation, either C corporation or the S corporation rules apply. An LLC owned by more than one individual is taxed as a partnership by default. As with a single-owner LLC, a multiple-owner LLC may make an election to be taxed as a corporation.


This brochure contains general information for taxpayers and  should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information. Copyright © 2017 Tax Materials, Inc. All Rights Reserved

Tuesday, December 19, 2017

Taxpayers Who Receive an IRS Notice

Read these tips for taxpayers who receive an IRS notice.

Receiving a notice from the Internal Revenue Service is usually no cause for alarm. Every year the IRS sends millions of letters and notices to taxpayers. In the event one shows up in the mailbox, here are ten things you should know.
  1.  Don’t panic. Many of these letters can be dealt with very simply.
  2.  Don’t ignore it. Most of these letters have a “reply by” date. Inaction can lead to additional interest and penalties or more aggressive action from the IRS.
  3.  Call your tax professional. Your tax professional is available to help you, is familiar with your situation, and has experience dealing with the IRS. Utilize his or her expertise. He or she will generally want to see a copy of the letter to determine the next course of action. Some letters can be resolved simply by having you contact the IRS directly. Other, more complicated issues may require you to sign Form 2848, Power of Attorney and Declaration of Representative, to allow your tax professional to deal with the IRS on your behalf.
  4.  There are a number of reasons the IRS sends notices to taxpayers. The notice may request payment of taxes, notify you of a change to your account, or request additional information. The notice you receive normally covers a very specific issue about your account.
  5.  Each letter and notice offers specific instructions on what you need to do to satisfy the inquiry.
  6.  If you receive a notice about a correction to your tax return, you should review the correspondence and compare it with the information on your return.
  7.  If you agree with the correction to your account, usually no reply is necessary unless a payment is due.
  8.  If you do not agree with the correction the IRS made, it is important that you respond as requested. Respond to the IRS in writing to explain why you disagree. Be courteous and respectful. Include any documents and information you wish the IRS to consider, along with the bottom tear-off portion of the notice. Mail the information to the IRS address shown in the lower left corner of the notice. Allow at least 30 days for a response from the IRS.
  9.  Most correspondence can be handled without calling or visiting an IRS office. However, if you have questions, call the telephone number in the upper right corner of the notice. When you call, have a copy of your tax return and the correspondence available.
  10.  Keep copies of any correspondence with your tax records. As with any tax issue, contact your tax professional to help you navigate your own unique situation.


Avoid Future Problems

You can minimize the likelihood of encountering future problems with the IRS by:
• Keeping accurate and complete records,
• Waiting to file your tax return until you receive all your income statements,
• Checking the records you receive from your employer, mortgage company, bank, or other sources of income (W-2s, 1098s, 1099s, etc.) to make sure they are accurate,
• Including all your income on your tax return,
• Following the instructions on how to report income, expenses, and deductions, and
• Filing an amended return for any information you receive after your return has been filed.

Consider filing your taxes electronically. Filing online can help you avoid mistakes and find credits and deductions that you may qualify for. Find a tax preparer whom you trust to prepare and e-file your return. An experienced tax preparer who is familiar with your personal situation is in a position to help you file a complete and accurate return. In addition, he or she will be able to advise you on the best course of action for responding to a notice should you receive one.


Taxpayer Rights

IRS employees are required to explain and protect your rights as a taxpayer throughout your contact with them.

Privacy and Confidentiality

The IRS will not disclose to anyone the information you give them, except as authorized by law. You have the right to know why they are asking you for information, how they will use it, and what will happen if you do not provide the requested information.

Professional and Courteous Service

If you believe that an IRS employee has not treated you in a professional, fair, and courteous manner, you should tell that employee’s supervisor. If the supervisor’s response is not satisfactory, you should write to the IRS director for your area or the center where you file your return.

Representation

You may either represent yourself or, with proper written authorization, have someone else represent you in your place. Your representative must be a person allowed to practice before the IRS, such as an attorney, certified public accountant, or enrolled agent. If you are in an interview and ask to consult such a person, then in most cases, the IRS agent must stop and reschedule the interview.

You can have someone accompany you to an interview. You may make sound recordings of any meetings with the IRS’ examination, appeal, or collection personnel, provided you tell them in writing 10 days before the meeting.

Payment of Only the Correct Amount of Tax

You are responsible for paying only the correct amount of tax due under the law—no more, no less. If you cannot pay all of your tax when it is due, you may be able to make monthly installment payments.

Help With Unresolved Tax Problems

The Taxpayer Advocate Service can help you if you have tried unsuccessfully to resolve a problem with the IRS. Your local Taxpayer Advocate can offer you special help if you have a significant hardship as a result of a tax problem.

Appeals and Judicial Review

If you disagree with the IRS about the amount of your tax liability or certain collection actions, you have the right to ask the Appeals Office to review your case. You may also ask a court to review your case.

Relief From Certain Penalties and Interest

The IRS will waive penalties when allowed by law if you can show you acted reasonably and in good faith or relied on the incorrect advice of an IRS employee. The IRS will waive interest that is the result of certain errors or delays caused by an IRS employee.

This brochure contains general information for taxpayers and  should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information.

North Carolina and South Carolina residents and business owners are welcome at the offices of Franklin P. Sparkman, CPA Charlotte, Waxhaw, and Lancaster. A locally trusted name for accounting, bookkeeping, tax preparation for businesses and personal finances.

Monday, November 27, 2017

Business Financing— Don’t Intermingle Funds

Intermingling Funds

A common problem with single-owner and other closely-held corporations is intermingling of funds. This occurs when a corporate shareholder uses his or her personal checking account for corporate deposits or payment of corporate expenses.

Separation of funds can be a key in preserving the liability protection of the corporate veil. Courts can pierce the corporate veil by finding that the corporation is an “alter ego” of the shareholder, essentially stating that the corporation is not separate and distinct from the individual as evidenced by the intermingling of finances.

Also, a shareholder who deposits personal funds or pays personal expenses from the corporate checking account is intermingling funds. For the same reasons as the reverse, courts can cite this as evidence that the corporation is not a separate and distinct entity from the individual.

Tax Problems Caused by Intermingling Funds

Unintended tax consequences can occur when personal and corporate funds are intermingled. When a shareholder provides funds to or on behalf of a corporation, there are several different types of tax treatment that may apply, depending on the circumstances. For example, when a shareholder provides funds to a corporation, it can be classified as one of the following transactions.
• Capital contribution.
• Loan to the corporation.
• Repayment of a loan from the corporation.
• Expense reimbursement.
• Purchase.


When a shareholder purchases an item for the corporation from his or her personal funds, that shareholder is considered to have provided funds, or made a contribution, to the corporation. Classification is determined by how the transaction is structured and the circumstances surrounding the transaction. Providing funds to corporations without careful planning can cause unintended tax consequences.

If an individual takes funds from a corporation checking account, the transaction can be classified as:
• Taxable dividend.
• Nontaxable distribution.
• Nontaxable expense reimbursement.
• Wages.
• Loan to the shareholder.
• Repayment of a loan from the shareholder.

Failure to carefully structure transactions when taking disbursements from a corporation can result in otherwise nontaxable transactions becoming taxable, in addition to opening the corporation up for a court to pierce the corporate veil.

Example: Lucy owns a home and garden store. She recently incorporated in order to shield herself from liabilities of the business. Lucy meant to open a corporation checking account, but she never got around to it. Since she had been doing business with her suppliers for many years as a sole proprietor, she continued to purchase supplies and inventory on account and pay the invoices from her personal checking account. Unfortunately, Lucy had a particularly bad year, and she was successfully sued for $1 million by a customer injured by a Venus Flytrap purchased at Lucy’s store. She also fell under audit by the IRS.

Since Lucy’s equity in the store was only one thousand dollars ($1,000), the plaintiff’s attorney asked the court to pierce the corporate veil. The court agreed, stating that as evidenced by the intermingling of funds, the corporation did not operate as a separate legal entity and was a mere alter ego for Lucy. Lucy became personally liable for the damages caused by the carnivorous plant.

When Lucy made purchases for her business from personal funds, she had been writing off those amounts as expenses on her corporation tax return. The IRS determined that the amounts paid amounted to capital contributions, not payment of expenses, and adjusted her taxable income upward for the year under investigation. Lucy’s accountant tried to cheer her up by noting that in some cases, expenses paid by a shareholder have been disallowed altogether and the deductions permanently lost.


Court Case: A taxpayer operated a tax preparation business as a sole proprietor. The taxpayer later incorporated but continued to have clients make checks out to him personally and treated funds received from the business as his own. No evidence of any employment agreement existed between the taxpayer and his corporation. The court ruled that the taxpayer operated his business as a sole proprietor and the income earned should be treated as earned not by the corporation but by the individual and be subject to self-employment tax. (Reginald Jarrett, et al, T.C. Summary 2008-94)

Personal use of corporate assets. A similar situation with intermingling funds occurs when personal assets are used by the corporation and vice versa. If corporate assets are used for personal purposes, the IRS can reclassify expenses reported on the corporation tax return as expenses attributable to the shareholder rather than the corporation. On the other hand, if a corporation uses personal assets owned by the shareholder, this could indicate lack of separation of the shareholder and corporation, opening up the possibility of having the corporate veil pierced.

Court Case: The taxpayer was engaged in several business activities, including real estate, entertainment services, and interior design. She incorporated her business in New York under the name Real Services, Inc. The taxpayer’s books were not well-kept, and she frequently used the corporation checking account to intermingle funds. Business deposits were made into the account, but checks were written for items such as birthday presents for family members, tuition costs for the daughter of a friend, and contact lenses for her friend. The taxpayer was audited by the IRS and taxes were assessed on unreported income.

The taxpayer argued she was not individually liable for the taxes. Instead, her corporation, Real Services, Inc., should be liable because the corporation received the funds in question. The court decision determined the corporation was a sham and stated the corporation had the characteristics of an alter ego, including:

“The intermingling of corporate and personal funds, undercapitalization of the corporation, failure to observe corporate formalities, such as the maintenance of separate books and records, failure to pay dividends, insolvency at the time of a transaction, siphoning off funds by the dominant shareholder, and in the inactivity of other officers and directors.” (Zabetti Pappas, T.C. Memo 2002-127)






This article contains general information for taxpayers and  should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information. 

If you have questions about business tax preparation or business accounting, please contact a professional CPA via http://fpsparkmancpa.com/contact-us/

Tuesday, October 17, 2017

College Financial Aid Planning: Federal Financial Aid and More

students, group

College Financial Aid Planning

Individuals who want to attend college but cannot afford the costs outright must find alternative funding through various types of financial aid. Many factors affect eligibility for federal financial aid; therefore, all students should apply for financial aid every year even if they think they do not otherwise qualify.

FAFSA. The Free Application for Federal Student Aid (FAFSA) is the first step in the financial aid process. Students use the FAFSA to apply for federal student aid, such as grants, loans, and work-study. The FAFSA must be submitted for each year the student wants financial aid.

Income tax return. If the student (or parents) needs to file an income tax return with the IRS, it is recommended that it is completed before filling out the FAFSA. 

Expected Family Contribution. The questions on the FAFSA are required to calculate the student’s Expected Family Contribution (EFC). The EFC measures the student’s family’s financial strength and is used to determine the student’s eligibility for federal student aid. The EFC is split between an expected amount contributed from the student (usually more) and an expected amount being contributed from the parents.

Student Aid Report. A student’s EFC will be listed on their Student Aid Report (SAR). The SAR summarizes the information submitted on the student’s FAFSA. 

Financial need. Financial need is the difference between the EFC and the college’s cost of attendance (which can include living expenses), as determined by the college. The college will use the student’s EFC to prepare a financial aid package to help meet financial need. 

Need analysis formula. To determine financial need, a need analysis formula measures the parents’ and student’s assets and income. Assets are measured as follows:
• Assets in the student’s name are assessed at a maximum rate of 20%, whereas parents’ assets are assessed at a maximum rate of 12%. 
• The assets of other children are not considered by the need analysis formula. 
• Specific types of property (automobiles, computers, furniture, books, clothing and school supplies, boats, and appliances) do not count as assets. 
• Retirement funds and pensions are generally not considered assets. 
• Annuities and life insurance policies are generally not considered assets. 
• Small businesses owned and controlled by the student’s family are excluded as assets. However, a partnership where the family owns 50% of the business is not excluded. 
• Consumer debt (such as a credit card balance) is not counted against assets and income. 
• Only debt secured by property (mortgage on home or business loan for equipment) is counted against assets and income.

Planning Strategies

Income Strategies

• Avoid selling items that will produce a capital gain during the base year (first year of financial aid application) because capital gains are treated like income.
• Avoid taking money out of a retirement fund to pay for educational expenses. In general, retirement funds  are not counted as an asset in the need analysis formula. However, if distributions are made, this converts a sheltered asset into an included asset. Therefore, it is more beneficial to spend down cash in a bank account first.
• Reduce parents’ income to increase eligibility for financial aid when parents’ AGI is close to $50,000. If the parents’ AGI is under $50,000, then the family may qualify for the Simplified Needs Test (SNT) which disregards assets when determining the EFC.

Asset Strategies 

• Avoid saving money in the student’s name. Assets should be saved in the parents’ name because parents’ assets are assessed at a much lower rate for determining need (12% for parent versus 20% for student). 
• A section 529 college savings plan saved in the parents’ name has minimal impact on financial aid eligibility, and one owned by a grandparent has no impact on the student’s eligibility. 
• Avoid paying the student a salary from the family business. 
• Spending down the student’s assets, preferably within the first year, before using any parent asset will leave the family with the most money left over after graduation. 
• Put parent assets in the name of another sibling not in college because assets of other children are not considered by the need analysis formula. 
• Buy necessary purchases prior to applying for financial aid. Specific types of property (automobiles, computers, furniture, books, clothing and school supplies, boats, and appliances) do not count as assets. • Grandparents who wish to pay for college should pay money directly to the school to avoid increasing parental or student assets by giving money to them outright. Or, if the grandparents wait until the child has graduated, they could pay off the student loans instead. 
• Make maximum contributions to retirement funds because these assets are not considered by the needbased formula. 
• Buy life insurance policies or tax-deferred annuities because these assets are not considered by the needbased formula.

Consumer Debt

Paying off credit card debt and automobile loans will increase eligibility for financial aid by reducing available cash.

Mortgage Debt

To maximize eligibility for financial aid, reduce cash and other assets by prepaying mortgage debt. In addition, parents could take out a home equity line of credit each year to pay for the student’s school expenses. Interest payments would be tax deductible and the loan would reduce assets considered by the need-based formula.

Change in Financial Circumstances

A student should contact his or her financial aid office if the student or his or her family has unusual circumstances that should be taken into account in determining financial need. Some examples of unusual circumstances are unusual medical or dental expenses or a large change in income from last year to this year.

Non-Federal Assistance

Information about other non-federal assistance may be available from foundations, religious organizations, community organizations, and civic groups, as well as organizations related to a student’s field of interest, such as the American Medical Association or American Bar Association. Check with the parents’ employers or unions to see if they award scholarships or have tuition payment plans.

Independent Status

If a student is considered an independent, he or she does not have to include any parental income or assets on the FAFSA application. A student is considered an independent if he or she: 
• Gets married before submitting the FAFSA. 
• Attains age 24.


This brochure contains general information for taxpayers and  should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information. 

Thursday, September 14, 2017

Business Tax Preparation: Repairs vs. Improvements

Reporting Property Repairs vs. Property Improvements

Internal Revenue Code section 162 generally allows a current business deduction for the cost of repairs and maintenance incurred during the year. On the other hand, Internal Revenue Code section 263 requires the capitalization of amounts paid to acquire, produce, or improve tangible property. Since repairs and improvements often have very similar characteristics, it can be tricky to classify the expenditures. However, correct classification is important because the cost of repairs can generally be deducted in the year paid, while improvements must be capitalized and the deduction taken over several years through depreciation.

An improvement requiring capitalization occurs with an addition to or partial replacement of property that results in a betterment of the unit of property, restores the unit of property, or adapts the unit of property to a new use. The cost of an improvement must be capitalized and depreciated over a certain number of years as if the improvement were separate property.

Example: Nina has a truck she uses for her contracting business. Her truck was damaged and the cost to repair it is considered a deductible repair cost. Routine maintenance on the truck such as engine tune-ups and oil changes are also currently deductible expenses. Nina added a hydraulic lift to her truck, which improved its functionality. The expense of adding the lift is an improvement that must be capitalized and depreciated over the truck’s remaining useful life.

Common Repairs vs. Improvement


⇒ Repairs
Costs that:
  • Keep the property in good operating condition.
  • Do not materially add value to the property.
  • Do not substantially prolong the property’s life. 

Deductible as a current expense.
Examples:
Wall repair and repainting.
  • Repainting inside or out.
  • Fixing gutters.
  • Fixing damaged carpet.
  • Fixing leaks.
  • Plastering.
  • Replacing broken windows.
  • Servicing office equipment.
  • Cleaning and lubricating machinery.

⇒ Improvements
Costs that:
  • Improve or better the property.
  • Restore the property.
  • Adapt the property to new or different uses.
A green/garden roof on a office building.
Must be capitalized and depreciated.*
Examples:
  • Room additions.
  • Remodeling.
  • Landscaping.
  • New roof or flooring/carpeting.
  • Wiring upgrades.
  • New heating/cooling and plumbing systems.
  • Installing a security system.
  • Replacing gravel driveway with concrete.

* The cost of an improvement is depreciated according to a prescribed class and recovery period of the underlying property. Most non-real estate assets such as computers or machinery are depreciated over five or seven years, with residential real estate depreciated over 27 ½ years, and nonresidential business property over 39 years.

Example: Glen owns a rental house and the roof on the unit is leaking. Glen is comparing the costs and benefits of fixing the leaking roof with replacing the entire roof. Glen can deduct the cost of repairing the leak as a rental repair expense. However, if Glen completely replaces the roof, the new roof is an improvement because it increases the value and lengthens the life of the property. Glen must capitalize and depreciate the cost of a new roof.

Business Use Requirement

Repairs are deductible only on business-use or rental property. A homeowner with no business use of the home does not benefit when an expenditure is classified as a repair rather than an improvement. Repairs are nondeductible personal expenses, while an improvement increases the basis of the home and reduces any potential gain on the sale of the home. Example: Olive repaired a hole in the wall in her living room, replaced a few broken tiles in her bathroom, and sealed some cracks in her windows. She spent $1,200 making repairs to her home. Because Olive does not use her home for business purposes, the $1,200 is a personal expense and is not deductible.

Recordkeeping

Keep good records and ask contractors to provide an itemized list showing repairs and separately stated improvements and costs. If repairs and improvements are all completed at the same time, the IRS may classify the entire cost as improvement, even if some of the expenses were for repairs.

Court Case: The taxpayer incurred expenses to add a lunch area, restrooms, and a loading and unloading ramp to his existing manufacturing plants. In addition, the interior of the plants were painted and ‘fixed-up.’ The taxpayer claimed a repairs and maintenance deduction for all of the expenses. The IRS disallowed the deduction, explaining that the additions/improvements were made under a proposal and were required to be capitalized. The court agreed with the IRS, noting that the additions of the lunch room, restrooms and ramps constitute nondeductible capital expenditures that were more than merely keeping the property in an ordinarily efficient operating condition. The additions and improvements not only increased the value of the plants, but also aided in adapting them to a different use. The painting of the facility would qualify as a deductible repair if those expenses were standing alone, however, when made as part of an entire capital investment in the improved property, as they were in this case, they must be treated as a capital expenditure. In addition, the court noted that it was not possible to determine from the evidence submitted what portion, if any, was attributable to deductible repairs. Without a segregation of expenses, the deduction cannot be allowed and all expenditures must be capitalized. (Rutter, T.C. Memo 1986-407, August 28, 1986)

This article contains general information for taxpayers and  should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information. 

to find a tax advisor and accountant.
 

Tuesday, August 15, 2017

Newlyweds Tax Tips

Tips for Newlyweds

Updating your status from single to married may bring about some unanticipated changes, including changes relating to your taxes. While wedding planners don’t typically use an IRS checklist, here are a few things to keep in mind when filing your first tax return as a married couple.

As with any tax issue, contact your tax professional to help you navigate your own unique situation.

Notify the Social Security Administration (SSA)

If one of you has taken on a new name, report the change to the SSA. File Form SS-5, Application for a Social Security Card.

It is important that your name and Social Security number match on your tax return. The IRS will match your information with records provided by the SSA and, if the records don’t match, any electronically filed return will be rejected and any paper filed return will have the mismatched individual’s personal exemption cancelled until the error is corrected.

Avoid making a name change too close to tax season. While the SSA can process a name change in about two weeks, the delay in data-sharing between the SSA and the IRS can make any change near the end of the year problematic. In such situations, it may be advisable to file the tax return using your maiden name and change your name with the SSA after the return has been filed.

Form SS-5 is available on the SSAs website at www.ssa. gov, by calling 800-772-1213, or by visiting a local SSA office. A copy of your marriage certificate and driver’s license or passport will be required.

Notify the IRS If You Move

The IRS will automatically update your new address upon filing your next tax return, but any notices the IRS sends in the meantime may not get to you. The U.S. Postal Service does not forward certain types of federal and certified IRS mail. IRS Form 8822, Change of Address, is the official way to update the IRS of your address change. Download Form 8822 from www.irs.gov or order it by calling 800-TAX-FORM (800-829-3676).

Notify the U.S. Postal Service

To ensure your mail, including mail from the IRS, is forwarded to your new address, you’ll need to notify the U.S. Postal Service. Submit a forwarding request online at www.usps.com or visit your local post office. Most post offices will not forward refund checks so be sure the IRS has your correct address. Using electronic direct deposit for refunds can prevent them from being delayed due to address mix-ups.

Notify Your Employer

Report your name and/or address change to your employer(s) to make sure you receive your Form W-2, Wage and Tax Statement, after the end of the year.

Notify Financial Institutions

Financial institutions with which you do business need to be notified to ensure that any Forms 1099 are sent to the proper address. This would include banks and brokerage firms, as well as employer-sponsored retirement plans.

Newlyweds Tax Tips

Check Your Withholding

If you both work, keep in mind that you and your spouse’s combined income may move you into a higher tax bracket. The IRS Withholding Calculator, available at www.irs.gov, can help you determine whether you need to give your employer(s) a new Form W-4, Employee’s Withholding Allowance Certificate. Use the results to fill out and print Form W-4 online and give it to your employer(s).

Select the Right Tax Form

Choose your individual income tax form wisely because it can help save you money. Newlywed taxpayers may find that they now have enough deductions to itemize on their tax returns, rather than taking the standard deduction. Itemized deductions must be claimed on a Form 1040, not a 1040A or 1040EZ.

Choose the Best Filing Status

Your marital status on December 31 determines whether you are considered married for that entire year for tax purposes. The law generally allows married couples to choose to file their federal income tax return either jointly or separately in any given year. Figuring the tax both ways can determine which filing status will result in the lowest tax.

For most married couples, filing jointly will result in a lower tax liability. This is especially true if there is a significant difference in your incomes. The so-called “marriage penalty” only applies to couples who both earn relatively high salaries. Certain situations may make it more advisable for married taxpayers to file separately.
• If both spouses have their own itemized deductions, such as medical deductions, they may be able to claim higher overall deductions because of the percentage limitations on Schedule A.
• If one spouse has past due debt with the IRS or another government agency, such as child support obligations or student loans, filing separately will prevent the other spouse’s share of any refund from being used to offset debts for which he or she is not liable.
• If one spouse has messy or missing records, or is thinking of taking a risky tax position, the other may want to file separately to avoid becoming liable for potential additional taxes or penalties.

Planning for your wedding may be over, but don’t forget about planning for the tax-related changes that marriage brings. More information about changing your name, address, and income tax withholding is available on www.irs.gov, or contact your tax professional.

Simple Projections

Based on your tax information from last year, it will be easy to prepare a dummy return to show what your tax situation would be if you had been married. You can print out Form 1040, other tax forms, and tax tables from www.irs.gov. On the blank forms, combine tax information from last year’s returns. For example, combine the wage amounts from both returns and enter the total on Form 1040, line 7, of the blank form. Do the same for items such as interest, other income, and include deductions if either person itemized.

Use filing status, deductions, and exemption amounts as if you had been married. The resulting tax and refund or amount due will give you an indication of whether your current withholding is sufficient to cover your tax liability when incomes are combined and will also help identify any problems that may need to be addressed when you file as married taxpayers.

Contact Franklin P. Sparkmam

There are many events that occur during the year that can affect your tax situation. Preparation of your tax return involves summarizing transactions and events that occurred during the prior year. In most situations, treatment is firmly established at the time the transaction occurs. However, negative tax effects can be avoided by proper planning. Please a local accountant Waxhaw NC or accountant Lancaster SC in advance if you have questions about the tax effects of a transaction or event, including the following:
• Pension or IRA distributions. • Significant change in income or deductions.
• Job change. • Marriage. • Attainment of age 59½ or 70½.
• Sale or purchase of a business. • Sale or purchase of a residence or other real estate.
• Retirement. • Notice from IRS or other revenue department.
• Divorce or separation. • Self-employment.
• Charitable contributions of property in excess of $5,000.
Go to fpsparkmancpa.com 

This brochure contains general information for taxpayers and should not be relied upon as the only source of authority.  Taxpayers should seek professional tax advice for more information.