When It Hurts To Be Married – Tax Debt

May 21, 2018 Leave a comment

When it hurts to be married tax debtFor obvious reasons, I’ve changed the names and identifying circumstances. If you know a couple with these names, I promise they are not the people in this story.

Marybeth and Jack met when they were both in college and started living together after they’d been an item for a little over a year. Sharing one apartment cut down on their expenses. This allowed Marybeth to quit her part time job. She used the extra time to start a business installing and maintaining small vegetable gardens for people who wanted ultra-fresh veggies but were too busy to tend a garden. To Marybeth’s surprise, her business took off, and to keep up with customer demand, she had to hire another person. She got so busy and was making so much money, she sees no reason to continue working on a university degree. She did so well, she was  able to pay for the rest of Jack’s education, including law school. No student loans involved. Just cash payments. Life was good.

Fast forward 10 years … It’s now 2016. Jack and Marybeth have an 8-year-old daughter, Claire. Jack has a law degree and a steady job with  a salary of $89,000 and benefits,  but Marybeth’s business is in trouble. In 2012 she started doing commercial landscaping jobs. In 2015 she  got a couple of big contracts that required going into debt to purchase equipment and pay salaries. One of the contracts was with a residential developer I’ll call Procrustean Homes. Procrustean went under and ended up in a Chapter 7 bankruptcy. Marybeth had put a total of $183,000 into the project, expecting to get back $357,000. Instead, she got nothing except the $150,000 line of credit she still had to pay off.

One of the reasons Marybeth felt confident enough to bid the project with Procrustean is that she’d had her best year ever in 2015, making a net profit of $448,935. This was a substantial increase over her prior year income, and the quarterly estimated tax payments she’d made were not nearly enough to cover the tax due when her 2015 tax return was due in 2016. So Marybeth and Jack both signed a joint tax return with a liability to the US Government of $93,441. Which they couldn’t pay. Marybeth reported a net operating loss of $22,359 for 2016. If she had been filing as a single person, she could have carried the loss back to 2015, which would have helped with the debt. But here’s where filing status comes in.

Marybeth and Jack have been presenting themselves to the world as spouses for years, even though they never got a marriage license. They’ve also been filing tax returns as though they’re married. During the time when Marybeth was working and Jack was a student, and even after Jack started working as a lawyer, the couple paid lower taxes if they checked the Married Filing Jointly box on their tax return. They just kept doing the same thing, year after year. They even came to think of themselves as married.

Fast forward again to 2018. Marybeth has scaled back her business and is beginning to recover, but she still has not been able to make a dent in the 2015 tax liability. Jack is now making a salary of $105,000 per year plus benefits, but this has to be used to cover living expenses and taxes on Jack’s salary.  The couple still has to make their $3262 per month payment on their house and pay the $2800 leases on their cars. Claire is in private school. And so forth.

The IRS has already levied on Marybeth’s and Jack’s bank account, but they’ve moved to a new bank and think they can breathe easy for a little while. Then one day Jack gets his pay check, and it’s only a fraction of what it should be. The IRS has levied on his salary. Since he signed that joint tax return back in 2015, he is “jointly and severally liable” for Marybeth’s tax debts. Jointly and severally liable means the IRS can collect up to the whole amount due from either Jack or Marybeth. This doesn’t mean they can collect more than the amount owed. For example, they can’t collect 25% from Marybeth and $100 from Jack. But they sure can collect 100% from Jack, and they will if something is not done to stop the process.

Jack and Marybeth could have greatly reduced their problems by using Single filing status in 2015. Using Married Filing Jointly in the past certainly complicates the situation.

To Be Continued.

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What You Lose By Checking Married Filing Separately

May 20, 2018 Leave a comment

95644726 - young family budget cartoon illustrationWhat You Lose When You File Separately

There can be compelling reasons to use the Married Filing Separately tax filing status. This is especially true for non-community-property states, but sometimes it can be a good idea to file separately in community property states too, such as when a couple is in the process of getting a divorce.

Before checking the Married Filing Separately box on your tax return, though, you want to be aware of the tax breaks you stand to lose, which include:

  • The child and dependent care tax credit
  • The adoption credit
  • The Earned Income Credit
  • Tax-free exclusion of U.S. bond interest
  • Tax-free exclusion of Social Security benefits
  • The credit for the elderly and disabled
  • The deduction for college tuition expenses
  • The student loan interest deduction
  • The American Opportunity Credit and Lifetime Learning Credit for higher education expenses
  • The deduction of net capital losses
  • Traditional IRA deductions
  • Roth IRA contributions

When there’s a divorce in progress, I often recommend filing separately even if it means the couple as a whole pays higher taxes. The reason is that even if the divorce decree requires the wife to pay the taxes, this only gives the husband the right to sue her if she doesn’t follow through. The IRS doesn’t give a rat’s ass what the divorce decree says. If you sign a joint return, you have what’s called Joint and Several Liability for the taxes owed.

Joint and several liability means the IRS can collect up to 100% of the tax debt from either party. If the wife agreed to pay the taxes but doesn’t follow through, the IRS can legally collect 100% if the tax due  from the husband.

If you should find yourself in a predicament like the husband in the above example, all is not lost. You may be able to file for Innocent Spouse Relief.

Filed under Taxes

Reporting Gains and Losses From Recreational Gambling

March 7, 2012 Leave a comment

Reporting Gains and Losses From Recreational Gambling

Here’s a common scenario: Gavin spends a weekend in Las Vegas. His overall position from gambling is negative, but he made a couple of lucky bets. He receives Form W-2G showing $3,000 in winnings. If he does not report the $3000 on his Form 1040, the IRS computers will be likely to catch the discrepancy between their records and Gavin’s tax return, and Gavin will receive a notice that he owes additional taxes.

If Gavin already has itemized deductions that total to more than his standard deduction, he can deduct up to $3000 of gambling losses on Schedule A (itemized deductions) to offset the winnings.

Here’s how it works:

Scenario 1 – Overall Positive Outcome From Gambling

Gavin’s W2-G says $3,000, but this does not include losses of $2,500 from slot machines. Gavin also spent $645 on transportation and lodging.

Gavin can take the following deductions on Schedule A:

Gambling losses   $2,500
Travel Expenses    $   500

Taxable Gain         $   -0-

Scenario 2 – Overall Negative Outcome From Gambling

Gavin’s W2-G says $3,000, but this does not include losses of $2,500 from slot machines and $1,000 from other bets.

Gavin can take the following deduction on Schedule A:

Gambling losses   $3,000

Taxable Gain         $   -0-

In other words, you can offset gambling winnings with gambling losses and expenses, but only up to the amount shown on Form W-2G. A recreational gambler cannot use gambling losses or expenses to reduce his pre-gambling taxable income.

But what if Gavin’s itemized deductions total less than the standard deduction? In this case, Gavin will have to report his $3000 of winnings from Schedule W-2G. Period. He will not be able to offset any of the gambling winnings with gambling losses or other expenses, even though he had an overall loss from his gambling activities.

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How to Deduct Entertainment Expenses Part 2

March 6, 2012 Leave a comment

Can I deduct my wife´s dinner?

Ian is a software engineering consultant who works for a small firm of which he is a 25% owner. He much prefers working at his computer to going out on the town, but occasionally he finds it necessary to take clients or prospective clients to dinner.

“I can talk about software technology all day,” he told me, “but I´m a bumbling buffoon when it comes to socializing. The only way I manage to get through those ordeals where I´m supposed to wine and dine a client is to take Susan [Ian’s wife]. She´s just incredible. She can talk to anybody about anything. So … since the client would have a terrible time with just me there, can´t I deduct my wife´s dinner?”

The rule is that the cost of the dinner for both the host’s and the customer’s or client’s spouse is deductible if it´s not practical to entertain the client or customer without his or her spouse. But Ian needs Susan at dinner, regardless of the presence or absence of his client´s wife. Can Ian deduct the cost of Susan´s meal, even if the client comes alone? IRS would be likely to challenge this — the greater the amount deducted for Susan´s meals, the more likely it would be of interest to IRS.

For deductions of this sort that do not fit neatly within a section of the Tax Code or Treasury Regulation, you would want to have extra documentation. For example, Ian´s firm might want to record minutes of a meeting where they discuss the need for Ian to entertain clients and prospects, together with Ian´s difficulties in social situations and Susan´s social skills. If the other partners in Ian´s firm agree that Susan´s presence at client dinners will be very likely to help the firm increase sales and retain existing clients, it would be difficult for IRS to argue convincingly that the cost of Susan’s meals is not an ordinary and necessary business expense.

When is entertaining not entertainment?

In general, the deduction for meals and entertainment expenses is 50% of what you actually spend (75% for the transportation industry). But in some cases, the cost of a meal looks a lot more like a regular business expense than an entertainment expense.

Allan has a weekend business leading walking tours in Manhattan. A regular feature of each tour is a box lunch or snack pack for each participant, included in the price of the tour. In Allan´s case, the cost of lunch and snacks is 100% deductible, as Costs of Sales or Customer Supplies.

Likewise, for film or music critics, travel agents, food critics, certain costs that would ordinarily be 50% deductible as entertainment expenses are 100% deductible as regular business expenses. As always for costs of activities that people generally do for fun and pleasure, it is important to have abundant documentation of your profit motive and the relationship between the activity and the business. Calling yourself a film critic because you view lots of movies and tell your friends about them is probably not going to fly

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How to Deduct Entertainment Expenses

March 6, 2012 Leave a comment

 

Most business owners know that certain entertainment expenses are deductible under some circumstances, but judging by the large number of questions we get on this topic, I don´t think many people actually know the rules.

Like all business deductions, entertainment costs must be “ordinary and necessary” in order to qualify as tax deductible. If your business is a used furniture shop, it´s not very likely that the cost of taking one of your customers to dinner and a movie would be an ordinary and necessary business expense. On the other hand, it could be, if for example the customer you take out for the evening is furnishing a motel and is prepared to spend $45,000 on furniture.

The dictionary definition of entertainment is “something that amuses, pleases, or diverts,” activities that are pleasant, fun; in other words, entertainment is the opposite of job, labor, work. Congress and the IRS, along with most people in general, associate doing business with work — the opposite of entertainment. Therefore, in order for a business owner to convince IRS that she was having fun and working at the same time, the business owner has to satisfy a high standard of documentation (never mind that there are times when taking certain customers out to dinner is one of the very last things a business owner would choose to do for pleasure).

Sara is a financial planner who specializes in retirement planning for employees of small businesses. Emily owns a janitorial service that has 12 employees. For months Sara has been trying to get an appointment with Emily to show her how setting up a flex plan for her employees would make good financial sense for both the business and the employees, but Emily never has time. Finally, Sara says, “You have to eat lunch anyway. Why don´t you let me take you to your favorite restaurant, and we can talk about employee benefits over lunch.”

Here is the information Sara needs to record in order for the cost of taking Emily to lunch to qualify as a deductible business expense:

1. The location — Mavis´s Downtown Country Cooking
2. Names of people entertained — Emily (in “real life” you would want to include the person´s last name), owner of Clean as a Whistle Janitorial Service
3. Date — November 8, 2011
4. Business purpose — Discuss flex plan with business owner
5. Amount spent — $35

Treasury Regulations state that this information must be recorded in a timely manner — in other words, you should record the information soon after the entertainment event rather than waiting until the day before an IRS audit.

The location, date, and amount spent are already on the receipt Sara gets from the restaurant, so all Sara needs to do is write Emily´s name and the business purpose somewhere on the receipt and make sure the receipt is put into the proper place in her files.

Mavis´s Downtown Country Cooking is 7.5 miles from Sara´s office, so Sara also had a mileage deduction to record in connection with taking Emily to lunch. Some business owners find it convenient to keep a record of both entertainment costs and mileage in their appointment calendars. IRS auditors like to be able to cross check mileage and entertainment records against an appointment calendar or organizer. They are trained to look for inconsistencies, such as a receipt from McCormick & Schmick´s, November 8, 2012 claimed as a business entertainment expense “J. Smith — discussed potential referrals” and an entry on the calendar for November 8, 2006 that reads, “Sally´s birthday party — McCormick & Schmick´s 7:30”

 

 

 

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How To Document Vehicle Expenses for the IRS

March 2, 2012 Leave a comment

HOW TO DOCUMENT VEHICLE EXPENSES FOR YOUR TAX RETURN

You may not have kept perfect records in the past, but you can begin now to document your business vehicle use. If the IRS should audit tax return for prior years, when you were not keeping good records, you can sometimes use current records as supplemental documentation for the prior years. The ideal documentation for your business automobile mileage would be the following:

  • Mileage log clearly showing the date, address you drove to, and business purpose. Examples: (1) 2/21/2011, 548 North Main, purchase office supplies, odometer out: 24937, odomenter in: 24945; (2) 2/21/2011, 23 NE Loop 410, call on prospective client Smith Construction, odometer out: 24945, odomenter in: 24960
  • Oil change or repair receipts toward the beginning and end of the year, providing 3rd party substantiation of your total mileage for the year;
  • Calendar showing appointments that match your mileage log. Example: 2:00 Monday Feb 21, 2011 – John Smith, Smith Construction 23 NE Loop 410
  • Some (most) people are in a hurry when they get into the car to go to a business appointment. If they keep a mileage log at all, it will often be on a sporadic basis. It’s best to have a log, but if you do not have a complete log, you can still substantiate your mileage using a calendar and third party documentation of your total mileage. In addition to repair or oil change receipts, you can use receipts for gasoline purchased and calculate your total mileage using this formula: miles driven = gasoline purchases/average price per gallon x miles per gallon. For example, if you spent $2000 for gasoline for 2010 and the average price of gasoline during 2010 was $2.75, you purchased about 727 gallons of gasoline in 2010. If you car travels an average of 20 miles per gallon of gasoline, your approximate mileage for 2010 would be 727 x 20 = 14,540 miles.
  • Once you have proved your total mileage for the year, you will need to show how much of that mileage was for business purposes. The following documents are useful for this: (1) a calendar that shows your business appointments; (2) invoices sent to clients or customers for work performed at the client’s or customer’s location; (3) print-out of Mapquest or Google Maps route between your office and the location.
  • A narrative description of your driving habits can also be helpful. Example: My base of operations is my office, located in my home. Each morning, I answer my email and return phone calls. Then I drive to my first appointment. I usually call on 4 or 5 prospective new customers each day, Monday through Friday. I also call on 1 or 2 existing customers each day, to make sure they are happy with the services they are receiving. My sales territory covers all of San Antonio and the surrounding small cities. I drive an average of 55 miles each day calling on prospective and existing customers. I also drive to the bank to make deposits once a week, and drive to purchase office supplies once every 2 or 3 weeks. 

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Improving Your Business By Lowering the Stress Level

February 18, 2012 Leave a comment

The video below includes information that could be very useful to apply to one’s personal life, but I found the implications for business management more fascinating.

The video mentions specific health problems associated with stress, such as plaque in arteries, shortened telomeres, ineffective immune systems, a tendency to store fat in the abdominal area.  I was aware of these before watching the video, but I was surprised to see that stress is also associated with damage to the hippocampus region of the brain. The research was not described in detail, so I do not know how much evidence there is that stress actually causes the health problems.  It’s conceivable, for example, that people with damaged brains might be less able to cope with life and thus be under more stress than people with healthy brains. The theory that abdominal fat results from high levels of glucocorticoids in the blood was mentioned. Since stress causes the body to shut down all systems not essential for fight-or-flight, it would make sense that the blood flow to the hippocampus region would be reduced when a person is under stress (the hippocampus is responsible for consolidation of short term memory to long-term memory).

The diseases associated with chronic stress clearly result in employee absences from work due to illness.  Less obvious is the cost of stress in terms of lower productivity.

The Whitehall cohorts studies of British civil servants showed a direct correlation between lower hierachical status, stress, poor health and higher mortality.

One of the main causes of  job-related stress is lack of control.  I have found that even highly structured jobs can allow employees some control.  Here are some examples:

  • Allowing employees the maximum flexibility possible in setting their own schedules;
  • Listening carefully to employees’ suggestions for improving the business (employees often have some excellent ideas, so in addition to giving them control over their working lives, you can also improve the way you operate your business)
  • Noticing employee performance and letting them know you appreciate it
  • Basing compensation on performance

Here’s the video:

While browsing through my favorite blogs, I came across an article on a related topic, the effect of happiness on learning and productivity.  This is actually a paleo diet blog, but I never fail to learn something useful about life in general when I visit. There’s an embedded video of a Ted Talk given by Shawn Achor:

http://weightmaven.org/2012/02/18/quote-of-the-day-37

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Excludable Gifts

February 7, 2012 Leave a comment

This question, in one form or another, comes up often enough that it’s worthwhile to address it here. One of my clients asked:

Is a gift under 13k tax deductible? I was reading the IRS website and I came across that.

Gifts are never tax deductible, unless they are made to a 501(c)(3) charity or similar organization. You can check here to search the IRS’s database for 501(c)(3) organizations:

http://www.irs.gov/charities/article/0,,id=249767,00.html

The Tax Code specifically excludes gifts from the gross income of the recipient. So if you were to give your child $5000 as a graduation gift, your child does not even have to mention that $5000 when he prepares his tax return.

So what’s with the special treatment of gifts under $13,000 my client saw on the IRS website?

Gifts are not taxable to the recipient, but they are sometimes taxable to the donor. The reason for this is that people used to avoid federal estate taxes by giving everything away on their deathbed. Since the estate tax is calculated as a % of asset owned at death, this strategy worked nicely to lower the estate tax to zero.

To prevent people from escaping estate taxes quite so easily, Congress passed a law that said any gifts given within 3 years of death had to be included in the donor’s estate. So people started making gifts earlier in life. For example, a person could set up a trust and make her grandchildren the beneficiaries. She could then contribute an office building to the trust and thus get the office building out of her estate. As long as the person lived at least 3 more years, the value of the person’s assets was reduced, and therefore the estate tax was reduced.

Congress reacted to this by passing a Unified Estate and Gift Tax. Over the course of his entire lifetime, a person can give up to a million dollars in gifts to recipients other than 501(c)(3) organizations. Gifts in excess of $1 million are taxable. To track the lifetime amount of gifts, a person if required to file a gift tax return every year a gift has been given.

But Congress really didn’t mean to require every birthday and wedding and graduation holiday gift to be reported. So the law exempts gifts of $13,000/year or less per donee. As long as you don’t give more than $13,000 to any one person during any one year, you don’t have to file a gift tax return. The $13,000 per donee exemption is per person, so a husband and wife can together give $26,000 per donee.

One of the ways to transfer a family business to the owner’s children is to give each child stock or LLC ownership units worth $13,000 each year.

To get back to my client’s question: no, you cannot take a deduction for gifts under $13,000; but you can exclude them when you calculate taxable gifts made during the year.

Filed under Accounting, Business, FAQ, Gift Taxes, Taxes Tagged with ,

Do People Really Get To Know New People at Networking Events?

February 4, 2012 Leave a comment

Many years ago, when I first started my law/CPA practice, one of the ways I marketed my services was to sell literally door-to-door. I’d stop by a business location and ask to talk to the owner. I never get tired of hearing about all the different ways people think of to make money, and I always enjoyed hearing about how each business was created. I found that people loved talking about their businesses, so it all worked out well. I had a great time doing door-to-door selling, and my prospects had enjoyable conversations. I even picked up a few clients, some of whom are still using my services all these years later.

Another sales tactic I tried was attending “networking” events. I went to a few that were structured events, such as lunches where you’d move from place to place for each course and have somewhat in-depth conversations with random people. I got a couple of clients that way but, all in all, I didn’t find it worth while. The unstructured cocktail party type of networking event was even worse.  My experiences usally went like this: I’d wander around having meaningless conversations with people, gain a collection of business cards that were meaningless afterwards, and either leave, or end up with another lawyer or CPA who didn’t need my services.

Turns out that my experiences with networking events may not have been unusual. Last month, Wired’s Frontal Cortex Blog had an article by Jonah Lehrer, Opposites Don’t Attract (And That’s Bad News). Lehrer describes a 2007 Columbia University study by two psychologists, who hosted a networking event (which they called a “mixer”) and tracked each attendee’s encounters via electronic name tags. They found that, while the attendees did meet a few new people at the event, they tended to engage in long conversations only with people they already knew.

Even more interesting is a study first published last year by Angela J. Bahns, Kate M. Pickett and Christian S. Crandal. They tracked friendships among university students, and found that students at a large school, whose student population included students with diverse backgrounds, tended to choose friends whose backgrounds and opinions were very much like their own. Students at smaller universities were more likely to get to know people unlike themselves, presumably because there were fewer potential friends to choose from.

Lehrer did not discuss online social networks, but the results of the Bahn et al study would lead one to expect that there would be even greater similarities within online groups than within the groups of students at a large university. A 2009 study, Homophily, Cultural Drift, and the Co-Evolution of Cultural Groups, bears this out (homophily is the principal that like attracts like — that is to say, the opposite of the principal that opposites attract.).

These studies are not surprising. It seems quite natural for people to want to hang out with others who share many of their opinions, whose childhoods were similar to their own, who make about the same amount of money, who follow the same sports.  On the other hand, you can learn a lot more from people who are different from you. Also, people who are different from you, who are in different lines of work, are more likely to need your products or services than people just like you.

So is it worth going to networking events if you make a real effort to engage in extended conversations with people who are different from you?  Or more accurately, with groups of  people who are similar to each other but different from you, since people at networking events hang out with people like themselves.  I don’t think it would work. For example, if I go to a networking event and try to hang out with a group of long-haul truck drivers, I’m going to have a difficult time breaking into the conversation. It’s probably going to make them feel uncomfortable having someone there who is not one of them.

Networking events must work for some people, or there wouldn’t be as many networking events as there are. My guess is that they work best for the people who organize them. When you work together with a small group of people to organize an event, you have a situation more like the small universities in the Bhan study — you and your fellow organizers have time to really talk and get to know one another. That’s the lesson I’m taking away from all these studies and my own experiences — don’t attend networking events unless you’re one of the organizers.

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How Government Regulation Stifles Creation of Jobs

January 10, 2012 Leave a comment

This is a blog entry posted by a Hungarian entrepreneur: http://www.arcticstartup.com/2012/01/09/this-is-why-i-dont-give-you-a-job

He explains that he would not hire a woman, because the cost of required maternity leave is prohibitively expensive; nor would he hire someone over 50, because he would not be able to fire the person if the person did not perform the work adequately.

This is an extreme example of the harmful effect of government interference with the right of employers and employees to enter into agreements.

When laws raise barriers against small businesses rather than creating a system that fosters the freedom of business owners to contract freely with people who wish to work for compensation, the end result, when the barriers get too high, is a situation in which the only thing keeping the economy going at all is the black market.

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