Pay Less Tax on Your Investments

It’s great to accumulate wealth by investing and saving you money, but did you know that taxes can take a large bite from your investments? Every investor, including those with 401(k)’s, IRA’s, and traditional brokerage accounts need to be aware of the impact of taxes. Here are a few tips and items to watch out for:

401(k)’s: A 401(k) can be a great way to save money for retirement as it is automatically deducted from your paycheck every time you get paid. If you are in the 25% tax bracket, every $100 you contribute saves $250 in taxes, plus savings for state taxes as well. You want to contribute as much as possible to reduce your taxes and save for retirement, especially if your employer has a matching contribution.

There is one common mistake that I do see often with 401(k) accounts and that is withdrawing money before retiring. It could be because you really need the money or you switched jobs and cashed out your account. You must resist the temptation to do this! Generally, there is a 10% early withdrawal penalty plus you will owe income taxes on the money withdrawn. This can easily add up to a third or even half of the money lost to taxes that you have withdrawn!

IRA’s: An IRA (individual retirement account) has similar tax characteristics of a 401(k). A strategy to maximize the tax-efficiency of your IRA may be to convert some or all to a Roth IRA. A Roth IRA has more favorable tax aspects as there are no taxes when you make a qualified withdrawal. Before making this decision, a thorough analysis should be done to make certain this strategy is beneficial for your situation.

Traditional Brokerage Account: A regular taxable investment account needs to be monitored closely to make sure you are not unnecessarily paying taxes. There are three straightforward ways to do this:
- Invest in tax-efficient mutual funds, ETF’s, and reduce the number of times you trade in your account. Every time stocks or bonds are sold, it may result in additional taxes
- Hold your investments for longer than one year to pay lower capital gains tax rates. This strategy compliments the first point.
- Compare the returns of tax-free municipal bonds to regular bonds to see which produces the higher overall rate of return.

Bad Tax Planning

Tax planning can prevent you from overpaying taxes, but it has to be done before the year is over. Good tax planning takes a proactive approach, and bad tax planning includes either not planning, breaking the law, or taking it upon yourself without using a competent tax professional.

Without planning you may not be able to take advantage of the ever-changing tax laws. When we work with business clients either monthly or quarterly we are able to understand their business finances much better. By doing so we can suggest proactive ways to reduce taxes, run their businesses better, and help with cash flow and profitability. For example, if your business is doing well, it makes sense to review the current structure to make sure that it is tax-efficient. Our services are designed to save much more in taxes and produce more value than our fees.

A bad strategy is to pay for personal expenses through the business and take a deduction for it. Personal expenses should be kept separate and paid for personally. An IRS auditor can easily spot this, assess more taxes, and even assess penalties of 20% or more. And of course, underreporting your income is not wise either and may result in criminal prosecution.

I know what I know and know what I don’t know. I use other qualified professionals when it comes to legal matters, insurance, and healthcare. If you take it upon yourself to do your own tax planning, you usually end up unknowingly paying more in taxes than the cost of using a professional. The key is to make certain that you choose the right professional and ask a lot of questions.

Did You Have Damage From Hurricane Irene?

Hurricane Irene caused a lot of property damage due to intense winds and rainfall. Many areas along the East Coast lost power for days and had flooding that has not been seen before. Most importantly, I hope that you were all safe.

Due to damage incurred from the hurricane, you may be able to deduct some of the damage to your property and belongings. These are called casualty losses and the definition is as follows:

A casualty is the damage, destruction, or loss of property resulting from an identifiable event (such as a hurricane, storm, or car accident) that is sudden, unexpected, or unusual.

The rules can be complex when figuring out your deduction. Generally, you can deduct your loss by using this formula: the loss minus insurance proceeds, then subtract $100. Finally, subtract 10% of your adjusted gross income from that figure to arrive at your deductible loss. Also, you need to be an itemizer in order to deduct casualty losses.

Let’s simplify with an example: Your car originally purchased for $30,000 is now worth $15,000. It is completely destroyed by Hurricane Irene, and your insurance reimbursed you $10,000. Your loss is then $15,000 - $10,000 = $5,000. Then subtract $100 to arrive at $4,900. Finally, subtract 10% of your adjusted gross income (let’s assume it is $40,000, then multiply by 10%) of $4,000. Your deductible loss is $900.

The rules are different for business owners. You may even be able to file an amended return from the prior year to receive a refund. As you can see the rules can be complex, so do not hesitate to contact our office with any questions.

Taxable or Non-Taxable?

Which items do you think are taxable and which are not? The answers are below.

1. Workers compensation
2. Educational assistance
3. Cancelled debt
4. Expense reimbursements
5. Fringe benefits
6. Bartering
7. Hosting a party and receiving payment (such as a candle party)
8. Life insurance proceeds
9. Unemployment benefits
10. Federal income tax refund

Taxable: cancelled debt, fringe benefits, bartering, hosting a party, and unemployment benefits

Non-taxable: Workers compensation, education assistance of $5,250, expense reimbursements, life insurance proceeds, and federal income tax refund

There are always exceptions and the rules are constantly changing. If you ever have a question about the taxability of an item, do not hesitate to contact our office.

Save Taxes by Taking the Home Office Deduction

The IRS allows business owners and employees to deduct expenses for using part of their home for business purposes. This can help to save income taxes as well as self-employment taxes. For every $1,000 of additional deductions, a self-employed person may save around $500! Here are the rules:

The first rule is that the area you use for business must be used exclusively and regularly for business. This means that the guest room that you use as an office cannot be used for even a single night to host your guests.

The second is that your home must be your principal place of business. To determine if your home is your principal place of business you must use it for administrative or management activities such as billing customers and recordkeeping.

If you are an employee there are other criteria that must be met as well. You must use your home for the convenience of your employer and you must not rent any part of your home to your employer.

What can be deducted exactly? You can deduct items such as mortgage interest, property taxes, insurance, utilities, repairs and maintenance, and depreciation of your house. Even if you itemize and deduct mortgage interest and property taxes on your tax return, it is more advantageous to someone who is self-employed to deduct a portion of these expenses as business expenses. The reason is to save self-employment taxes.

Although some believe the home office deduction will increase your chance of an audit, this should not discourage taxpayers from taking this valuable deduction. As long as you follow the rules and keep good records, you should not be concerned. Keeping good records and adhering to the rules applies to all other deductions as well.

Do You Watch Shark Tank?

You have probably heard of the show Shark Tank, which airs on ABC on Friday nights. The show is about entrepreneurs who pitch their products and ideas to a group of wealthy investors who are referred to as “sharks.” Hopefully, the sharks will bite and offer to invest some of their money in the fledgling businesses.

Many times the sharks pass up on investing in the new business, which is very eye-opening for the entrepreneurs. Other times, more than one shark wants to invest in the business because there is a lot of upside, and the risk seems worth it. There are some great business lessons to be learned by all of this.

Research the market: Are there enough people that are willing to buy your product? Even so, what price should you sell the product for and who is your target customer?

Business model: Is there enough profit to be made? Does it make sense to spend a lot of money for the return that is generated? Is it costly to acquire customers?

Careful with your funds: Some entrepreneurs invest so much money in their product that they are now broke. Worse yet is that the product may not even be viable. Even if the business is good, the entrepreneur is eager to sell and may end up taking a lowball offer just to recoup their own investment.

Lack of Experience: When a product is good, the problem that entrepreneurs may have is usually manufacturing, distribution, and additional capital. Instead of selling a piece of your company, an alternative is to work with qualified professionals, such as consultants, attorneys, accountants, and competent employees.

Businesses are started every day. Some are successful, but unfortunately, many are not. The key to increasing your chance of success is to plan and be well thought-out. Just like preparing to take a test as a student, you have to study ahead of time to increase your chances of getting an “A.”

Did You Get a Surprise After Filing Your Return?

Everyone loves to receive a much larger than anticipated tax refund, but what if you unexpectedly had to pay? There could be several reasons why, but it’s not too late to fix it for 2011.

Your filing status or dependents may have changed, perhaps from married to single, which usually causes you to pay more income taxes. Maybe you cannot claim your children as dependents anymore. For 2010, each exemption decreased your taxable income by $3,650.

Your business did very well and additional taxes were not paid. If you are self-employed, not only will you owe income taxes on each dollar of earnings, but you may be subject to self-employment tax, which is an additional 15.3%.

Taxable income has increased and certain deductions and credits have been phased-out. Once your income goes beyond $100,000 many tax credits, such as the child tax credit, are reduced. Real estate losses may also become reduced as well.

To prevent a negative surprise for 2011’s tax return, check your current withholdings to make sure that enough taxes are being withheld each paycheck. If you need to increase your withholdings, simply print out form w-4 from www.irs.gov or ask your employer and submit it to them with the additional amount you would like withheld. Any amount can be specified, such as $100. If you need help estimating, please contact our office.

Penny Wise, Pound Foolish

What do I mean by penny wise, pound foolish? Saving a penny, but it costs you a dollar. Here are a few examples:

Extreme Couponing: I watched an episode of extreme couponing and the first thought that came to my mind, aside from obsessive, is that the coupon clippers spend way too much time trying to save money. If an average family spends around $150 to $200 on groceries weekly, but they spend 30 hours a week couponing, aren’t they missing out on actually earning money? Multiply 30 hours by a minimum of $15/hour working and the result is $450. Even if $150 out of that goes towards taxes, it makes sense to try to earn more money than trying to save $150 by cutting coupons all day. One thought – my family cuts coupons, but we spend around 20 minutes a week maximum.

Not Investing in Yourself or Your Business: Aside from retirees, most individuals make the most income from earnings as a business owner or an employee. Don’t hesitate to intelligently invest money to further your career to produce more income, or to invest money into your business to produce more profits. Investing can be in the form of items designed to produce more income, such as marketing, or to reduce expenses, such as updating your equipment.

Spending Too Much on Items That Are Tax Deductible: Just because you can save taxes by paying loan interest, or by purchasing a new vehicle and equipment for your business, does it really make economic sense to do so? Spending a dollar to save a quarter is definitely penny wise, pound foolish.

Doing It Yourself or On the Cheap: Should you really do your own plumbing if you have never done it before just to save some money? It may end up costing you more when a real plumber has to fix your mess! I also see this with tax and accounting matters, but I am biased in this area, of course.

I still remember the first time I heard the penny wise, pound foolish saying (actually it was a partner at a large public accounting firm, and he said, “penny wise, dollar dumb,” but it still means the same thing). Think before trying to save!

Should Both Parents Work?

The birth of a child is one of the most amazing, memorable times of a person’s life. I remember the birth of our first daughter, Alana, and how I truly understood the expression, “walking on air.” The births of each of our other children were equally as amazing.

With the birth of a child, or perhaps your second, or third, or fourth in my case, comes an important question. Does it make sense for both parents to return back to work? There are many factors to think about, financial and non-financial, but here are some of the financial elements:

Daycare Expenses: The cost can vary significantly, but a typical range can be $800 to $1,200 per month per child. If you have one child in daycare and are paying $12,000 per year, the cost may make sense, depending upon income, but what about two children in daycare with expenses of $24,000 per year?

Commuting: If you take mass transportation into NYC from NJ, you may have to pay for parking at the local train station, the PATH train to NYC, and possibly the subway. If you drive into NYC the toll is $8. That comes to $40 a week in tolls and approximately $2,000 a year!

Dining Out: Almost everyone likes to go out to lunch a couple of times a week to break up the monotony of work. If you spend $10 twice a week, this adds up to $1,000 a year. Also, if both parents work, then you may be more likely to order take-out more often during the week due to time constraints. This may add another $1,000 to $3,000 a year.

Taxes: My favorite subject. This really depends upon your bracket, but even with a parent in the 15% federal tax bracket, once payroll taxes and state taxes are included, at least a quarter of your earnings will go towards taxes. Although, you do get a credit of around $600 for each child in daycare up to a maximum amount of $1,200.If you have two kids in daycare and work in NYC, you can easily spend $40,000 for the privilege of working! Unless you are able to work from home, have a flexible schedule, and even have a grandparent help out, working doesn’t sound so appealing.

My Customer/Tenant Didn’t Pay Me. Can I Deduct This on My Tax Return?

I get asked this question a lot, mostly from business owners. The answer to this question is that it depends. First a quick accounting lesson of cash vs. accrual. I promise not to keep it too technical!

If you are a cash basis taxpayer, then you record income or sales once you get paid, either by cash, check, or credit card. You also record expenses when you pay them, even if with a credit card.

For an accrual basis taxpayer, you record income when it is earned. For example, if you are a consultant and you sent an invoice to your client in January for December’s work, then you record the income from the invoice during December. The same goes for expenses, as it generally doesn’t matter when you paid your bill, but when you incurred the expense. This means that if you ordered supplies in December, but paid for them in January, you can deduct the expense in December.

Now to answer the original question: A cash basis taxpayer cannot deduct as an expense an outstanding invoice that was not paid by their customer, or tenant, if they are a landlord. Remember, the invoice was not included as income. On the other hand, an accrual basis taxpayer can deduct an expense for non-payment from a customer or tenant, as long as it is deemed uncollectible.

Most small business clients and landlords are on the cash basis method of accounting. It is much easier for record keeping purposes, and especially for income tax purposes.

What’s In Your Credit Report?

When we apply for loans, search for a job, or even take out an insurance policy, our credit report is used in the process. Your credit report shows all of your outstanding debts and lines of credit, including credit cards, mortgages, auto loans, and personal loans. Even accounts that have been closed or debts that have been paid off will be shown for years. All of this information is used to apply a credit score to you.

It is important to make sure that you pay all of your bills on time and don’t incur too much debt so that you maintain a healthy credit score. Sometimes, incorrect information may inadvertently be placed on your credit report, which will negatively impact your credit score. The higher your credit score generally means that you will pay a lower interest rate when applying for loans, which can save you hundreds or thousands of dollars each year.

Although there are a lot of companies that will provide you with your credit report for a fee, you are legally entitled to one free credit report per year by each of the three credit reporting companies. They are Equifax, Experian, and TransUnion. The website to obtain your free credit report is www.annualcreditreport.com, which is very user-friendly. I recommend obtaining one report every four months from a different credit reporting company so that you will never have to pay for them.

Once you have your report you should review it for accuracy. If there is a mistake, such as an account that shows that you have been late, you will need to contact the credit reporting company who issued the report to have it corrected. Most likely you will need to contact all three companies to have it straightened out.

One last note: According to the Federal Trade Commission (FTC), you should be skeptical of companies that claim they can repair your credit. Some of their business practices are fraudulent and many of the steps you can take yourself at little to no cost. You can go to this page: http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre13.shtm or email me and I will send you the FTC report about repairing your credit, including a sample dispute letter.

Keep It Separate

What should you keep separate? Business and personal expenses, of course! When you operate a business, including a sole-proprietorship, an LLC, corporation, or even a realtor, your business activities need to be kept separate from your personal expenses. This is especially important in the case of an audit by the IRS. Here are some best practices and areas where it matters most:

Have Two Separate Checking Accounts: One for your business and one for your personal expenses. When you have to pay for a personal expense, make sure to use your personal checking account. If you pay personal expenses through your business accounts, you will need to separately record these as draws or distributions, otherwise it may look like you are trying to deduct personal expenses as business expenses. The same applies to business expenses. Even though business expenses that are paid personally may still be deductible, chances are that you will not keep track of these expenses and forget to include them on your tax return, thus you end up overpaying taxes.

Business Vehicles, Property, and Equipment: Make sure that you purchase any business property in the name of the business. If the assets are on the books of the business, they need to be owned by the business.

If a Vehicle is in Your Name Personally: Corporate owner-employees may be able to reimburse themselves for vehicle expenses.

The bottom line is to keep your records clean, separate, and simple.

Do You Want to Audit-Proof Your Return?

While certain taxpayers have a higher chance of being audited, such as small business owners with a schedule C, how can you audit-proof your return? Actually, there is no way of insuring that you never get audited, but just in case you do, to make sure that you come out unscathed, there is one secret to help you to survive an audit – organized, clean records and documentation!

The secret is not glamorous, but it will save your nerves, your hard-earned money, and will most likely help you to be more successful. Some techniques for individuals without a business to audit-proof their returns are as follows:

- Make sure that you have received all of your W-2’s from every job during the last year, along with 1099’s for interest, dividends, and investment transactions. Leaving one of these off your return is sure to have the IRS send you a deficiency notice.
- Keep copies of all receipts, documents, and cancelled checks for charitable contributions and other expenses you claim on your return.
- Keep track of your cost-basis for your investments.
- I also recommend keeping your tax returns and supporting documents for at least 7 years.

For business owners:

You have much more responsibility, because you may have income tax returns, payroll taxes, and sales taxes that need to be filed, to name a few.

- Use a computerized bookkeeping program, such as QuickBooks. This will help you to run your business better as well.
- Reconcile your bank and credit cards accounts to your statements to make sure that you have recorded all information, and keep your statements.
- Keep all of your receipts and canceled checks to support your deductions.
- Maintain a vehicle mileage log for your business vehicles to prove business use.
- Document the business reason for your meals and entertainment expenses.
- Separate your personal expenses from your business. Even if you account for your personal expenses as a draw, it is much cleaner to pay for them personally.
- For sales that are not subject to sales taxes, make sure to be able to prove exemptions, with proper documentation for out-of-state sales for online retailers or tax-exempt certificates for contractors, for example.

The bottom line is that you need to be able to show proof for your expenses and deductions if you are audited or receive a notice from the IRS and state taxing agencies. Unfortunately, you are guilty unless proven otherwise.

What’s New for 2011?

On December 17, 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 was signed by President Obama. The main focus of the new laws was to extend the tax breaks for two more years that were enacted under President Bush, and were about to expire at the end of 2010. With the passage of the new laws, virtually all taxpayers, including lower income and wealthy, will benefit. Here is an overview:

Individual Tax Brackets: Individual tax rates are going to stay the same, from between 10% to 35% of taxable income. Without the new laws they were set to rise from between 15% to 39.6%. This is a benefit for all taxpayers.

FICA Payroll Tax Cut: For one year, employees will see a reduction of their FICA payroll taxes, from 6.2% to a reduced rate of 4.2%. Look for this change starting with your first paycheck of 2011.

Capital Gains and Dividends: The rate on capital gains and dividends will continue to be between 0% to 15%, depending upon your tax bracket. Capital gains were set to rise to 20%, and dividends were to be taxed as high as 39.6%.

Child Tax Credit: The child tax credit will continue to be $1,000 per child, and will phase-out for joint filers with more than $110,000 of adjusted gross income, and at $75,000 for single filers. The credit was set to be reduced to $500 per child.

There are many other changes that will positively impact almost all taxpayers. These include: a one-year patch to the alternative minimum tax, extension of the American opportunity tax credit, bonus depreciation, the earned income credit, and several more. If you have any questions on how these changes will impact you, don’t hesitate to contact our office.