Why mileage?

When it comes to cars, self employed individuals and small business owners usually have the same two questions: how much of the initial purchase can I write off, and should I keep up with mileage or actual expenses?  I will address the first question in a later article once Congress retroactively increases the depreciation limits for 2015.  The second question is a little more straightforward but with a few special circumstances to consider.  

Taxpayers that use a vehicle for business purposes and are not eligible to be reimbursed for their expenses can deduct either mileage or actual expenses on their tax return.  This is especially handy for self employed individuals that spend quite a bit of time in the car, such as real estate agents or commercial salespeople.  Often, taxpayers assume actual expenses will generate a higher deduction, but that is not always the case.  

Consider this: taxpayer drives a Toyota Camry that has a 17 gallon gas tank and gets 25 miles per gallon on average.  Assuming gas is $2/gallon, that means the taxpayer could drive 425 miles for $34.  The mileage rate for 2015 is 57.5 cents per mile, which means that same 425 miles would generate a $245 deduction using the standard mileage rate.  In this case, mileage is a much better method to use than actual expenses, and that will almost always be the case when the taxpayer has a fuel efficient vehicle in an environment of low gas prices.  

There are a few precautions to take when deciding whether to use actual expenses or mileage on a vehicle.  One is once the decision is made, it usually cannot be changed in the future i.e. a taxpayer cannot take actual expenses one year and mileage the next.  Another is the historical trend that the IRS is usually 1-2 years behind in aligning the mileage rate with expected actual expenses.  The mileage rate is designed to be one number that covers gas, maintenance, and depreciation on a per-mile basis.  From 2014 to 2015 the standard mileage rate increased 1.5 cents, while average gas prices decreased.  It can be expected then that the 2016 rate most likely will be less than 57.5 cents per mile due to the decrease in gas prices, but that will not necessarily be consistent with gas prices in 2016 (which could go up).

Mileage rates for 2016 are expected to be released close to the end of the year (December 2015).  My guess is 55 cents per mile.   

Idea$ 2014 - March: Taxes

As a part of the continuing Idea$ 2014 series, the month of March is dedicated to taxes. Specifically, this topic will address organizing tax documents, types of information to communicate to your paid preparer and ways for taxpayers to DIY if so inclined.  

The basics

Business returns for C Corporations (Form 1120) and S Corporations (Form 1120S) are due on March 17, 2014 (typically this is March 15, but since that falls on a Saturday this year, the due date is pushed to the next Monday).  Other returns including Partnerships (Form 1065), Fiduciary/Trust (Form 1041) and Individuals (Form 1040) are due on April 15, 2014.  

If the taxpayer cannot file by these dates, an automatic extension can be obtained.  The extension for corporations and partnerships extends the deadline to September 15, and the extension for individuals and trusts extends the deadline to October 15.  However, it is important to note that this is an extension of time to file, not time to pay.  If a taxpayer expects to owe tax on the return, a payment should be made with the extension in order to avoid penalties and interest.  

Income

Common income documents include:

• W2's - taxpayers that work for an employer should receive this showing their income and withholding amounts.
• 1099's - these are catch all documents for interest (1099-INT), dividends (1099-DIV), capital gains (1099-B), self-employment income (1099-MISC), social security (SSA-1099) and retirement income (1099-R).  
• Schedule K-1's - will be received if the taxpayer has an interest in a partnership, S-corporation, or trust.  

Deductions

Common deduction documents include:

• Tax payments for real estate and personal property
• Mortgage interest (Form 1098) - this form will include mortgage interest paid and possibly real estate taxes if they are paid through escrow
• Charitable contributions - for both cash and non-cash contributions, the taxpayer should have a receipt from the organization.  
• Medical expenses not reimbursed from a flexible spending account or other insurance program
• Tuition, fees and student loan interest
• Expenses for dependent care
• Contributions to retirement plans

Why the rush?

A taxpayer may wonder, if the return is not due until the middle of April, why get in a rush to organize their documents in March?  If the taxpayer is using a paid preparer, then it's safe to assume the preparer is working on several returns at one time, which can create a time lag between when information is submitted and the return is done.  If the taxpayer expects to owe tax, the earlier the return is done, the better they will be able to do cash flow planning to make a tax payment by April 15.  On the other hand, if the taxpayer expects a refund, then the same holds true in that the earlier the return is done, the earlier the taxpayer gets their refund.  Finally, it is always safe for the taxpayer to leave some time in case there are questions or additional documents that need to be obtained.  

D.I.Y

Taxpayers that have simple tax situations or are familiar with preparing tax returns already might want to prepare their own taxes.  There are a variety of options for taxpayers that want to go this route.  Most of the programs on the market now are easy to use and will walk the taxpayer through the return in an "interview format".  The most popular programs are TurboTax and TaxACT, both of which are available on CD or as an internet download.  There are pros and cons to the DIY method.  The pros are that it is relatively inexpensive ($25-$50 for software and efiling), the returns can be done at the taxpayers convenience, and the taxpayer does not have to share sensitive personal and financial data with anyone else.  However, the cons are that the taxpayer could report an income or deduction item incorrectly and helpful, reliable information is hard to come by on the internet.  Both of these could result in the taxpayer paying too much tax or filing an incorrect tax return.  Depending on the complexity of the taxpayer's situation, a professional tax preparer should be consulted.

Straight cash

Cash basis taxpayers can make decisions during these last few days of December to improve their tax situation.

Cash basis taxpayers report income and expenses in the year that they actually occurred.  This allows cash basis taxpayers to defer income or accelerate expenses as the situation requires.

Income

Income must be recognized by a cash basis taxpayer when it has been constructively received and is available to the taxpayer.  If a taxpayer receives a check in January for work performed in December, that income is taxable in the next year.  However, if a taxpayer receives a check in December for work performed in December but puts it in a drawer and doesn't deposit the check until January, this is still income to the taxpayer because it had been constructively received and was available in December.  With this being the case, tax basis taxpayers can manage their cash inflows at year-end by sending out bills later to defer collection to next year, or requiring customers to prepay if more cash/income is needed.

Expenses

Expenses can be recognized by a cash basis taxpayer in the year paid or charged.  Yes, you read that correctly, charged.  The IRS will allow charges on a credit card as cash basis expenditures, even if the bill is not paid until the next month.  This provides some wiggle room for businesses that have cash flow concerns at year-end, because they can use a credit card to make purchases instead of cash.

Cash basis taxpayers can also use the end of the year to stock up on capital assets, especially right now due to the expiring Section 179 and Bonus depreciation provisions.

A word of caution: just because an entity is a cash basis taxpayer does not mean that every cash expense is deductible.  All expenses must still be properly substantiated and properly deductible.

Cash basis taxpayers should also consider their business operations when making year-end decisions on spending.  Yes, buying $5,000 of office supplies on New Years Eve will reduce the tax burden on the entity, but will that cash outlay penalize the business operations in January?

Simplify my home office

Beginning in tax year 2013 (returns which will be filed during 2014), the IRS is offering a simplified option for the Home Office Deduction.  If the space in your house that is used exclusively for business on a regular basis is <= 300 square feet, then long gone are the days of keeping track of your cleaning, insurance, utilities and other household expenses. In previous years, the benefit of the deduction usually did not outweigh the trouble for getting together the information needed to make the calculation, especially when you have a self-employed person using a very small part of their house as an office (< 10% of the home).  The calculation also confused taxpayers because some parts of the deduction, like mortgage interest and real estate taxes, were allocated between the Schedule A Itemized Deductions and the Form 8829 Expenses for Business Use of Your Home.  Then there is the added headache of depreciation, which potentially was recaptured if you later sold the residence that housed the home office (meaning it had to be added back when you sold the house).

The simplified option is as its name implies: simple.  Take the square footage of your home office (not to exceed 300 square feet), multiply by $5, and that's your deduction.  There is no depreciation allowed and no splitting of household costs - all of your mortgage interest and real estate taxes go to the Schedule A.  Some of the characteristics of the deduction will remain the same, such as the space in the home must be exclusively used for business and the deduction cannot exceed your income from the business activity, but overall this simplified method will be much easier for some taxpayers.

It is important to note that the regular (original) option is still available, and can be beneficial to taxpayers that use a significant portion of their home exclusively for business.  The benefits of the deduction will be different for a consultant that has a 150 square foot office in their 3,000 square foot home than for a landscaper that has a 1,000 square foot garage used as a shop in a 2,500 square foot home.  It would also be beneficial for the taxpayer to do a rough calculation to see if the $5 per square foot is consistent with what they would be getting under the regular method.

Summertime tax tips

As the summer comes to a close we find ourselves at a transitional point in the year.  The kids are trading in their swimsuits and long days at the pool for backpacks, school supplies, and sack lunches.  I know with the temperatures hanging out in the 90's and 100's it's hard to believe, but fall will be here before you know it.  As this transition in the year happens, it also presents a good opportunity for people to do a little mid-year tax planning.  Below I have listed out a few things to consider as we enter the last five months of the year.

Clean out your closet

Take a look at your closet right now.  Do you see anything hanging up that you haven't worn all summer?  Maybe since last summer?  This is a great chance to go through your closet and bag up any clothes, shoes, and accessories that you feel comfortable passing along to a new owner.  Put all those clothes in a box or a bag and drive them down to your local charity (such as Goodwill) and make your donation.  Don't forget to get a donation receipt, fill out your personal information, list your donated items and assign a conservative value to them.  

Look at your FSA and HSA balances

There are five months left in the year.  But in those five months, you will probably go to the doctor and the dentist at least once, maybe the eye doctor, and possibly have to fill a prescription.  If you have sporty kids at home, you'll probably also been spending some time getting physicals for their various activities.  If you participate in an FSA, HSA, or flex spending account with your employer, this is a good time to see what your balance is, how much you expect to contribute for the remainder of the year, and compare that to your expected expenses.  Remember, in most of these plans you have to use it or lose it.  

Amended tax info

Is there an ominous envelope sitting on your counter at home with the words "IMPORTANT TAX INFORMATION ENCLOSED" that you haven't had a chance to open?  There's a good chance it is from your investment broker with corrected tax reporting information regarding your investments.  Or, it could be from your mortgage company discussing private mortgage insurance premiums.  Either way, you should take a look and discuss with your tax preparer to see if you need to amend your tax return.  

Changes in tax situation

Has 2013 been a year of change for you?  Maybe you bought your first (or third) house, maybe you had your first (or third) kid, or maybe you got nervous and sold a big part of your investment portfolio to avoid the ups and downs of the market.  All of these changes could have an impact on your 2013 tax return which could result in you getting a big refund or having a big balance due in April 2014.  To avoid this, talk with your tax preparer about the changes in your situation, your year-to-date withholdings from your paycheck, and any estimated tax payments you might have already made.  

Get up to date

The "fiscal cliff", "Obamacare", QE3, DOMA...there has been a barrage of news stories about all of these topics and you probably find yourself saying "I feel like this should affect me somehow?"  Well your intuition is correct.  For example, if you expect to make at least $250,000 this year, or you have significant income from investments such as interest, dividends, capital gains, partnerships, etc., or you are a small business owner with employees, then you are right in the crosshairs of several of these changes.  Touch base with your CPA to discuss your situation and consider any planning moves you can make in the closing months of the year.