Tax Challenges of Business Income

 

FS-2008-20, April 2008

WASHINGTON—Internal Revenue Service research indicates that understated business income contributes significantly to the tax gap, with the majority understated by small businesses.

To assist small business and self-employed taxpayers better understand their reporting obligations, this fact sheet addresses the issue of income and how to determine gross income.

Business Income, Gross Receipts or Sales

If there is a connection between any income received and a business, the income is business income. A connection exists if it is clear that the payment of income would not have been made if the business did not exist and operate.

Small business owners and self-employed taxpayers must report on their tax returns all income received from their businesses unless specifically excluded by law. In most cases, business income will be in the form of cash, checks and credit card charges.

But business income can be in other forms, such as property or services. There are many forms, including: bartering, real estate rents, personal property rents, interest and dividend income, canceled debt, promissory notes, lost income payments, damages, economic injury payments, as well as kickbacks.

All income earned is taxable. Directing payment of income to a third party does not remove the reporting and payment requirements for small businesses and self-employed taxpayers.

Cost of Goods Sold

Some businesses may make or buy goods to sell. If so, these businesses may deduct the cost of goods sold (COGS) from their gross receipts. To determine these costs, the value of inventory at the beginning and end of the year must be calculated.

There are several factors that go into determining COGS, including: inventory at the beginning of the year; purchases less cost of items withdrawn for personal use; labor costs (generally applies to manufacturing and mining operations); materials and supplies (generally a manufacturing cost); other costs (generally applies to manufacturing and mining operations); and inventory at the end of the year.

Inventory, net purchases, cost of labor, materials and supplies, and other costs are added together. Inventory at the end of the year is subtracted from this total to determine COGS.

Gross Income

To calculate gross income, first determine net receipts (gross receipts minus returns and allowances) and minus the cost of goods sold. Returns and allowances include cash or credit refunds made to customers, rebates and other allowances off the actual sales price. Then add any other income, including fuel tax credits. Gross income must be determined first before deducting business expenses.

Tools to Use

There are tools available to assist small business owners and the self-employed track and report income such as the use of: a formal set of books and records with strong; accounting/financial computer software; and separate bank accounts for business and personal income and expenses.

Small businesses and self-employed taxpayers greatly benefit by accurately recording and reporting all income. Insufficient recordkeeping could cause income to be over-reported and too much tax paid or too little income reported and too little tax paid.

The Small Business and Self-Employed One-Stop Resource is a Web based tool. It contains a wealth of information to educate business owners and the self-employed on their unique tax filing and reporting obligations.

Another Web based tool is the Online Learning and Educational Products section of IRS.gov which allows business owners to view a streaming video of an IRS Small Business Workshop, order the Small Business Workshop on DVD, take an IRS course, or complete an online, self-directed version of a workshop taught live around the country.

These tools can help to more accurately determine income and expenses as well. There are benefits beyond accurate income and expense reporting to be gained. Formalized financial records will help small businesses when it is time to apply for loans or efforts to obtain capital for expansion.

Links:
• Publication 334, Tax Guide for Small Business
• Publication 583, Starting a Business and Keeping Records

New Law Eases Cell Phone Reporting

In 1989, when the old cell phone rules were developed, cell phones were expensive and considered a luxury item used primarily by executives.  Congress decided to tax them the same way it taxes the personal uses of employer-provided automobiles.  Under this classification, called “listed property”, employers are denied a tax deduction unless they document the cell pho9ne business use and business purpose.  Employees were required to include the value of their personal use in their income.

Starting in 2010, cell phones and similar telecommunication devices used for business are no longer subject to the “listed property” reporting requirements.  This means employers may deduct the cost of providing cell phones to employees for business-related use without having to satisfy the strict substantiation requirements for listed property.

Do I have to File a Tax Return?

 

IRS Tax Tip 2011-02, January 04, 2011

You must file a federal income tax return if your income is above a certain level; which varies depending on your filing status, age and the type of income you receive.

Check the Individuals section of the IRS website at http://www.irs.gov or consult the instructions for Form 1040, 1040A, or 1040EZ for specific details that may help you determine if you need to file a tax return with the IRS this year. You can also use the Interactive Tax Assistant available on the IRS website to determine if you need to file a tax return. The ITA tool is a tax law resource that takes you through a series of questions and provides you with responses to tax law questions.

There are some instances when you may want to file a tax return even though you are not required to do so. Even if you don’t have to file, here are seven reasons why you may want to:

1. Federal Income Tax Withheld You should file to get money back if Federal Income Tax was withheld from your pay, you made estimated tax payments, or had a prior year overpayment applied to this year’s tax.
2. Making Work Pay Credit  You may be able to take this credit if you had earned income from work. The maximum credit for a married couple filing a joint return is $800 and $400 for other taxpayers.
3. Earned Income Tax Credit  You may qualify for EITC if you worked, but did not earn a lot of money.EITC is a refundable tax credit; which means you could qualify for a tax refund.
4. Additional Child Tax Credit  This refundable credit may be available to you if you have at least one qualifying child and you did not get the full amount of the Child Tax Credit.
5. American Opportunity Credit  The maximum credit per student is $2,500 and the first four years of postsecondary education qualify.
6. First-Time Homebuyer Credit  The credit is a maximum of $8,000 or $4,000 if your filing status is married filing separately. To qualify for the credit, taxpayers must have bought – or entered into a binding contract to buy – a principal residence located in the United States on or before April 30, 2010. If you entered into a binding contract by April 30, 2010, you must have closed on the home on or before September 30, 2010. If you bought a home as your principle residence in 2010, you may be able to qualify and claim the credit even if you already owned a home. In this case, the maximum credit for long-time residents is $6,500, or $3,250 if your filing status is married filing separately.
7. Health Coverage Tax Credit  Certain individuals, who are receiving Trade Adjustment Assistance, Reemployment Trade Adjustment Assistance, or pension benefit payments from the Pension Benefit Guaranty Corporation, may be eligible for a Health Coverage Tax Credit worth 80 percent of monthly health insurance premiums when you file your 2010 tax return.

For more information about filing requirements and your eligibility to receive tax credits, visit http://www.irs.gov.

Links:

• Forms and Publications

• Earned Income Tax Credit

• First-Time Homebuyer Credit Information Center

• Health Coverage Tax Credit.

• 1040 Central

YouTube Videos:

Do I Have To File A Tax Return?  English | ASL | Text Script

To slash taxes, buy assets and lease them back to your company

This strategy works especially well with real estate and other assets that are likely to appreciate in value.

It's bad enough when you have to pay tax once to the IRS. But C corporation owners are hit with a double tax whammy: first, when the corporation pays tax, and second, when Uncle Sam taxes them personally on dividends paid out by the company.

Strategy: Buy property and assets personally and lease them back to your company.

That way, the company pays you deductible lease payments instead of nondeductible dividends, and you can offset the income with depreciation or amortization deductions.

That technique works particularly well with real estate and other assets that are likely to appreciate in value.

In fact, if your company already owns a business building, you can buy it from your company now and then lease it right back.

Example: sale-leaseback deal. Suppose your company bought its building years ago and has since depreciated it down to zero. You estimate that the building and adjacent land are currently worth $1.5 million. Your company needs a quick cash infusion for proposed expansion, but money is tight.

Solution: Buy the building from your company for $1.5 million—using mostly cash you've borrowed—and lease it back. Then you begin depreciating the building all over again, using a 39-year write-off period. Your company pays the going rate for rentals in your area, but the rental income is offset by the depreciation and other related expenses.

Your, company now has the cash it needs for expansion and can deduct rental payments for a building that had previously been fully depreciated.
In comparison, your company receives no tax deduction for money paid to you as dividends. The downside is that the company must pay tax on the gain.

Fly under IRS radar. This technique can be perfectly legal, but the IRS often casts a skeptical eye on such deals. To make sure your deal is legit and satisfies IRS standards, meet these five requirements:

1.    The property's useful life must exceed the lease term.
2.    Any lease renewal is set at a market value.
3.    The buyer reasonably expects to profit from the deal.
4.    The property is sold at a fair price, and the buyer assumes the risk of losing money.
5.    A valid nontax business reason exists for the rental (e.g., leasing assets instead of owning them can release working capital).

Keeping Good Records Reduces Stress at Tax Time

You may not be thinking about your tax return right now, but summer is a great time to start planning for next year and to make sure your records are organized.  Maintaining good records now can make filing your return a lot easier and it will help you remember transactions you made during the year.

Here are a few things the IRS wants you to know about recordkeeping.

Keeping well-organized records also ensures you can answer questions if your return is selected for examination or prepare a response if you receive an IRS notice. In most cases, the IRS does not require you to keep records in any special manner. Generally speaking, you should keep any and all documents that may have an impact on your federal tax return.

Individual taxpayers should usually keep the following records supporting items on their tax returns for at least three years:

• Bills
• Credit card and other receipts
• Invoices
• Mileage logs
• Canceled, imaged or substitute checks or any other proof of payment
• Any other records to support deductions or credits you claim on your return

You should normally keep records relating to property until at least three years after you sell or otherwise dispose of the property. Examples include:

• A home purchase or improvement
• Stocks and other investments
• Individual Retirement Arrangement transactions
• Rental property records

If you are a small business owner, you must keep all your employment tax records for at least four years after the tax becomes due or is paid, whichever is later. Examples of important documents business owners should keep Include:

• Gross receipts: Cash register tapes, bank deposit slips, receipt books, invoices, credit card charge slips and Forms 1099-MISC
• Proof of purchases: Canceled checks, cash register tape receipts, credit card sales slips and invoices
• Expense documents: Canceled checks, cash register tapes, account statements, credit card sales slips, invoices and petty cash slips for small cash payments
• Documents to verify your assets: Purchase and sales invoices, real estate closing statements and canceled checks

For more information about recordkeeping, check out IRS Publications 552, Recordkeeping for Individuals, 583, Starting a Business and Keeping Records, and Publication 463, Travel, Entertainment, Gift, and Car Expenses. These publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Do you need to Amend your Return?

 

IRS Summertime Tax Tip 2010-12

If you forgot to include some income or to take a deduction on your tax return – you can correct it by amending your tax return.

In some cases, you do not need to amend your tax return. The Internal Revenue Service usually corrects math errors or requests missing forms – such as W-2s or schedules – when processing an original return. In these instances, do not amend your return.

However, you should file an amended return if any of the following were reported incorrectly:

• Your filing status
• Your dependents
• Your total income
• Your deductions or credits

You may also elect to amend your 2009 return if you are eligible to claim the first-time homebuyer credit for a qualified 2010 home purchase. The amended tax return will allow you to claim the homebuyer credit on your 2009 return without waiting until next year to claim it on the 2010 return.

Use Form 1040X, Amended U.S. Individual Income Tax Return, to correct a previously filed Form 1040, 1040A or 1040EZ. Be sure to check the box for the year of the return you are amending on the Form 1040X, Line B. If you are amending more than one tax return, prepare a 1040X for each return and mail them in separate envelopes to the appropriate IRS processing center. The 1040X instructions list the addresses for the centers.

The newly revised Form 1040X (Rev. January 2010) now has only one column used to show the corrected figures. There is an area on the front of the form where you explain why you are filing Form 1040X.

If the changes involve other schedules or forms, attach them to the Form 1040X. For example, if you are filing a 1040X because you have a qualifying child and now want to claim the Earned Income Credit, you must attach a Schedule EIC, Earned Income Credit to show the qualifying person's name, year of birth and Social Security number.

If you are filing to claim an additional refund, wait until you have received your original refund before filing Form 1040X. You may cash that check while waiting for any additional refund. If you owe additional tax for 2009, you should file Form 1040X and pay the tax as soon as possible to limit interest and penalty charges. Interest is charged on any tax not paid by the due date of the original return, without regard to extensions.

Generally, to claim a refund, you must file Form 1040X within three years from the date you filed your original return or within two years from the date you paid the tax, whichever is later.

Form 1040X and instructions are available at IRS.gov or by calling 800-TAX-FORM    800-829-3676

Links:

Form 1040X, Amended U.S. Individual Income Tax Return