Monthly Archives: May 2015

Starting a New Business? What to Deduct and When

Starting a brand new business usually requires the expenditure of money on things like:

  • legal and accounting fees
  • licenses, permit, and other fees
  • the cost of investigating what it would take to create a successful business, including research on potential markets or products
  • advertising costs, including advertising for your business opening and creating a business website
  • office rent and utilities paid before the business begins operating
  • rental of business equipment such as computers and office supplies
  • costs for employee training before the business opens, and
  • expenses related to obtaining financing, suppliers, customers, or distributors.

Once your business begins, the cost of all of such items are deductible as business expenses. However, they are not so easily deducted if they are incurred before your business starts. Such business start-up expenses are capital expenses—costs that you incur to acquire an asset (a business) that will benefit you for more than one year. Normally, you can’t deduct these types of expenses until you sell or otherwise dispose of the business. However, a special tax rule allows you to deduct up to $5,000 in start-up expenses the first year you are in business, and then deduct the remainder, if any, in equal amounts over the next 15 years. (I.R.C. § 195.)

Example: Diana Drudge is sick of her office job. She decides to start a fashion design business.
Before her business begins, she spends $20,000 of her life savings on advertising. Her business finally starts on July 1, 2014. Because such advertising is a start-up expense, she can’t deduct the full cost in her first year of business—instead, she can deduct $5,000 of the expenses the first year she’s in business and the remaining $15,000 in equal installments over 15 years (assuming she’s in business that long). This means she may deduct $1,000 of the remaining $15,000 for each full year she’s in business, starting with the first year. However, Diana’s business is open for only six months her first year, so she may deduct only $500 of the $15,000 that year, plus the initial $5,000 she’s entitled to. Her total first year total deduction is $5,500.

Obviously, you want to spend no more than the first-year ceiling
on start-up expenses so you don’t have to wait 15 years to get all your money back.

Special Rules for Some Expenses

There are some costs related to opening a business that are not considered start-up expenses. Many of these costs are still deductible, but different rules and restrictions apply to the way they are deducted.


The largest expense many home business people incur before they start their businesses is for inventory—that is, buying the goods (or the materials to make them) that they will sell to customers. For example, if you decide to start an eBay business selling items you buy at flea markets, you would treat the items you purchase for resale as inventory. You deduct the cost of inventory as it is sold or if it become unsalable.

Long-Term Assets

Long-term assets are things you purchase for your business that will last for more than one year, such as computers, office equipment, cars, and machinery. Long-term assets you buy before your business begins are not considered part of your start-up costs. Instead, you must treat these purchases like any other long-term asset you buy after your business begins: You must either depreciate the item over several years or deduct the cost in one year under Section 179. However, you can’t take depreciation or Section 179 deductions until after your business begins.

Research and Development Costs

The tax law includes a special category for research and development expenses. These are costs a business incurs to discover something new (in the laboratory or experimental sense), such as a new invention, formula, prototype, or process. They include laboratory and computer supplies, salaries, rent, utilities, other overhead expenses, and equipment rental, but not the cost of purchasing long-term assets. Research and development costs are currently deductible under Section 174 of the Internal Revenue Code, even if you incur them before the business begins operations.

Organizational Costs

Costs you incur to form a partnership, limited liability company, or corporation are technically not part of your start-up costs. However, the rule for deducting these costs is the same as for start-up expenses. (I.R.C. § 248.) But, if you form a one-member LLC, you get no deduction at all if your start-up expenses exceed $5,000

When Does a Business Begin?

Once your business begins, the same expenses that were start-up expenses before your business began become currently deductible business operating expenses. For example, supplies you purchase after your business starts are currently deductible operating expenses, but supplies you buy before your business begins are start-up expenses.

So, just when does a new business begin? The courts have held that a new business begins for tax purposes when it starts to function as a going concern and performs the activities for which it was organized. (Richmond Television Corp. v. U.S., 345 F.2d 901 (4th Cir. 1965).) The IRS says that a venture becomes a going concern when it acquires all of the assets necessary to perform its intended functions and puts those assets to work. In other words, your business begins when you start doing business, whether or not you are actually earning any money.

For example, if your business involves providing a service to customers or clients—
such as accounting, consulting, financial planning, or law—your business begins when you first offer your services to the public. No one has to hire you; you just have to be available for hire. For example, a consultant’s business begins when he or she is available for hire by clients.

If you’re a knowledge worker—for example, a writer, artist, photographers graphic designer, computer programmer, app developer—your business begins when you start using your business assets to make saleable products. The products don’t have to be completed, nor do sales have to be solicited or made. Thus, an inventor’s business begins when he or she starts working on an invention in earnest, not when the invention is completed, patented, or sold. Likewise, a writer’s business begins when he or she starts working on a writing project.



Plan to Sell Your Company Someday? Slash Your Taxes Now

Unfortunately, minimizing the tax burden of your sale isn’t as simple as hiring a top-notch tax professional a few weeks before your closing. Some of the tax moves discussed below take time. So get up to speed on these tax strategies now and talk to the experts–a business broker, your accountant, a tax expert–to get your tax minimization plans in place sooner rather than later.


Tips for Minimizing Postsale Tax Liability

Regardless of whether you’re selling a sole proprietorship or a corporation, it’s important to understand the tax implications of the sale long before you pull the trigger on your business exit. There are several tax strategies.

  • Conversion to an S corp

    To avoid double taxation, consider converting your C corp to an S corp prior to sale. Although restrictions may apply, by converting to an S corp, shareholders are taxed for the gain on the sale, but the corporation avoids paying corporate-level tax. This significantly reduces the total tax liability on sale proceeds. But it can’t be done overnight–this conversion needs to be made 10 years prior to the sale of your business.

  • An installment sale

    An installment sale is one of the most common tax-deferment strategies for sellers of small businesses. In an installment sale, the buyer purchases either stock or assets using an installment promissory note, committing to pay a portion of sale proceeds over time. Sellers do not permanently avoid tax on sale proceeds, but this strategy delays taxes until payments are received and helps spread out the tax burden.

  • An ESOP sale

    Employee stock ownership plan, or ESOP, sales enable sellers to defer payment of tax on the sale of stock. As long as the ESOP owns at least 30 percent of the company’s stock postsale and the seller invests proceeds in qualified securities, it’s possible to create a tax strategy that defers the payment of taxes through a managed account. This creates a permanent tax savings for your estate following your death.

  • Qualified small business stock exception

    There is a provision in tax law that allows for an exclusion of gain from the sale of qualified small business stock, or QSBS. As of January 1, 2014, the QSBS exclusion is set at 50 percent for the sale of C corp stock in a company with total gross assets of $50 million or less. Be aware that other restrictions may apply and an AMT tax preference can further limit your tax savings. Talk with a tax professional to see if this could be an option for you.

The only thing worse than paying tax on the sale of a business is paying too much tax. Given the amount of money that changes hands in a typical business transaction, even small actions can significantly increase the size of your bank account when you exit your company. By working closely with a tax professional in the months or years leading up to the sale, you can improve your tax position and lay the groundwork for more money in the long run.


10 Easy Tips to Avoid Getting Scammed

We are all targets and we are all vulnerable. Criminals across the country and around the globe – small-time thieves and devious computer hackers – are working around the clock to steal your money and your personal information. There’s nothing you can do to guarantee you won’t get taken, but there are many things – some of them very simple – that can reduce the risk. Raedle / Getty Images

Con artists and disreputable companies will do or say whatever it takes to get what they want. So you need to be vigilant. Because once you wire off your money or give a crook your Social Security number, the damage is done. Life in the digital age does not come with an “undo” button.

With most scams the warning signs are there, if you look for them – let’s review the rules:

Be skeptical

Question everything: phone calls, mail solicitations, email offers, links on social media. Don’t take things at face value. Con artists know how to make their scams look and sound legitimate. They can doctor pictures, copy logos, fake testimonials. It’s also easy to “spoof” caller ID and create fake websites.

Think it through and check it out before you respond in any way. A phone call or quick web search could keep you from losing thousands of dollars or giving out very personal information. You can check out companies and offers with the Better Business Bureau, Federal Trade Commission and National Fraud Information Center.

Guard your personal information

Fraudsters use a variety of tricks to get you to divulge account numbers and passwords. They send bogus emails designed to look like it’s from your bank and make calls pretending to be with your credit card company.

There’s always a reason why they need your personal information. A common ruse is for a phone bandit to ask for your account number and PIN to solve a computer problem or to stop fraudulent transactions spotted on your account.

It doesn’t matter what they say – hang up! Those who need your account numbers, PINs or passwords already have them. They’d never call you or send you an email asking for them. When in doubt, contact the company in question by phone – use a number you know to be legitimate, from your statement or the phone book – and ask what’s up.

Your Social Security number is the key to your life. A thief can use it to steal your money and your identity. Social Security numbers are also used to access many financial and medical records. So guard that number and only give it out when absolutely necessary to someone you know and trust.

Beware of counterfeit checks

When you sell something online, never accept a check that’s made out for more than the agreed-upon price. Fraudsters will do that and instruct you to wire back the extra amount. The check may look legit, but it’s counterfeit. The bank may tell you the check has “cleared” and the money is in your account, but once that check is found to be bogus – which could take weeks – the bank will withdraw those funds from your account. That means you’ll be left holding the bag for all the money you wired off.

Take your time

Don’t let anyone rush you into making a purchase. The buy-now-or-else approach is designed to keep you from comparison shopping. Don’t fall for it. If they’re really offering a bargain, they don’t have to high-pressure you into buying on the spot. If the sales person tells you the price won’t be good if you walk out the door – turn around and leave.

Get it in writing

Verbal promises don’t count. It doesn’t matter what the salesperson tells you, the only thing that matters is what’s written down. Most sales contracts specifically state that verbal promises are not binding. That’s why you need to read, understand, and agree to the terms before you sign any contract.

Be wary of all links and attachments

It’s so easy to click on a link in a text, email, or social media post. It’s so tempting to open an email attachment, especially when the message says it’s a shipping invoice or some other document you’d want to see.

Fraudsters count on curiosity and that instant response to load malicious software onto computers, smartphones and other mobile devices. And with shortened URLs, you really don’t know where that link will take you – maybe a malicious site run by the crooks.

Unless it’s something you’re expecting and know for sure who it came from, don’t open that attachment and resist the temptation to click any links.

If you’ve really won a prize – it’s free!

Never pay to play a contest or to claim a prize. If the contest is legitimate, you’re not required to buy anything or pay any money to get your prize – that’s the law. You don’t have to send in a processing fee, pay shipping or handling charges, or provide your credit card or bank account numbers for any reason. And if you owe taxes on your prize, you pay them to the government, not the contest promoter.

Remember: You can’t win a contest you didn’t enter. If someone says you did, they’re lying.

Don’t be fooled by free merchandise offers or money back guarantees

Free is good, but be skeptical of ads that offer to send you a free sample. The initial product may be free, but they’ll probably make you pay for shipping and handling. To cover that charge, you’ll need to provide your credit or debit card number. Some dishonest companies then sign you up for additional monthly purchases – whether you realize it or not – which can be hard to stop.

A money-back guarantee is designed to get you to make a purchase you might otherwise skip. That guarantee is only as good as the company that offers it. Sometimes the rules are so restrictive it’s impossible to get a refund. For example, simply opening the package might void the offer. If you are allowed to return the product, you can expect to pay to ship it back.

Use a credit card for online and mail order purchases

A credit card gives you better fraud protection than a debit card – credit cards are governed by different federal rules. With a credit card, you can dispute an unauthorized charge and the credit card company must take that charge off your bill while it investigates. That’s not always the case with a debit card. You can also dispute a credit card charge if the merchandise doesn’t arrive or if it’s defective and the company won’t help you.



Tips for Paying Estimated Taxes

The United States has a “pay as you go” tax system in which tax payments are made to the IRS throughout the year, not as one lump sum when the tax annual return is filed. Employees have their income and Social Security and Medicare taxes withheld by their employers and paid the IRS quarterly or monthly. This includes business owners who have formed corporations to own and operate their businesses. However, most small business owners are not incorporated. Instead, they are sole proprietors (one-person businesses) or partners in partnerships or members of limited liability companies. Such business owners are self-employed for tax purposes.

estimated-tax-payments-660x369When you’re a self-employed no taxes will be withheld from your compensation by your clients and customers, or by your business itself. It’s up to you to pay your income and Social Security and Medicare taxes yourself. Ordinarily, this is done by making four annual estimated tax payments to the IRS each year.

You must pay estimated taxes if you expect to owe at least $1,000 in federal tax for the year. However, if you paid no taxes last year—for example, because your business made no profit or you weren’t working—you don’t have to pay any estimated tax this year no matter what your tax tally for the year. But this is true only if you were a U.S. citizen or resident for the year and your tax return for the previous year covered the whole 12 months.

You also don’t have to pay estimated tax if, in addition to running a business, you have an employee job and the amount withheld from your pay by your employer will amount to at least 90% of the total tax you’ll have to pay for the year.

When to Pay Estimated Taxes

You must ordinarily pay your estimated taxes in four installments, with the first one due on April 15, as shown in this chart:

Screenshot 2015-05-14 08.51.51

Don’t get confused by the fact that the January 15 payment is the fourth estimated tax payment for the previous year, not the first payment for the current year. The April 15 payment is the first payment for the current year.

You don’t have to start making payments for any given year until you actually earn income. If you don’t receive any income by March 31, you can skip the April 15 payment. In this event, you’d ordinarily make three payments for the year, starting on June 15. If you don’t receive any income by May 31, you can skip the June 15 payment as well and so on.

You can also skip the January 15 payment if you file your tax return and pay all taxes due for the previous year by January 31 of the current year. This is a little reward the IRS gives you for filing your tax return early. However, it’s rarely advantageous to file early because you’ll have to pay any tax due on January 15 instead of waiting until April 15. In other words, you’ll lose three months of interest on your hard-earned money.

How Much do You Have to Pay?

Ideally, the four estimated tax payments you make each year will add up to your tax liability for the year. However, if your income varies substantially from year to year, it can be hard to estimate how much you must pay during the year. If you don’t pay enough estimated tax, the IRS will impose a penalty.

Fortunately, there is a way to avoid having to estimate how much you’ll make this year. No matter what your income for the current year turns out to be, you won’t have to pay any penalties if the estimated tax you pay is at least the smaller of: 90% of your total tax due for the current year, or 100% of the tax you paid the previous year or 110% if you’re a high-income taxpayer (those with adjusted gross incomes of more than $150,000 or $75,000 for married couples filing separate returns).

Note that, if you’re a partner in a partnership or LLC member, you must pay individual estimated tax on your share of the partnership or LLC income whether or not it is actually paid to you. The partnership or LLC itself pays no tax.

Many self-employed people establish separate bank accounts to save up for taxes into which they deposit a portion of each payment they receive from clients. This gives them some assurance that they’ll have enough money to pay their taxes. The amount you should deposit depends on your federal and state income tax brackets and the amount of your tax deductions. Depending on your income, you’ll probably need to deposit 15% to 50% of your pay in the highest tax brackets. If you deposit too much, of course, you can always spend the money later on other things.

How to Pay Estimated Tax

Paying estimated tax is easy: you can do it by check, electronic funds withdrawal, or even by credit card. You should use IRS Form 1040-ES, Estimated Tax for Individuals, to pay your estimated tax. The form includes detailed payment instructions.

What if You’ve Paid too Little?

The IRS imposes a money penalty if you underpay your estimated taxes. Fortunately, the penalty is not very onerous. You have to pay the taxes due plus a percentage penalty for each day your estimated tax payments were unpaid. The percentage is set by the IRS each year. Currently, it’s about 3%. This is the mildest of all IRS interest penalties. Many self-employed people decide to pay the penalty at the end of the tax year rather than take money out of their businesses during the year to pay estimated taxes. If you do this, though, make sure you pay all the taxes you owe for the year by April 15 of the following year. If you don’t, the IRS will tack on additional interest and penalties. The IRS usually adds a penalty of 1/2% to 1% per month to a tax bill that’s not paid when due.

For more details on estimated taxes, refer to IRS Publication 505, Tax Withholding and Estimated Tax.