Prepaid Expenses 12-Month Rule

Most individuals and many small businesses use the cash basis method of accounting. With this method you record income when money is received and you record expenses when money is paid out. Tax deductions are taken in the year they’re paid for.

The general rule is that you can’t prepay business expenses for a future year and deduct them from the current year’s taxes. This means that generally an expense you pay in advance can be deducted only in the year or years to which it applies. Such an expense must be prorated over time rather than deducted in full in the tax year in which it is paid.

However, there’s an important exception called the 12-month rule. It lets you deduct a prepaid future expense in the current year if the expense is for a right or benefit that extends no longer than the earlier of:

  • 12 months after the right or benefit begins, or
  • the end of the tax year after the tax year in which payment is made

An example the IRS provides in Publication 538 is:

“You are a calendar year taxpayer and pay $10,000 on July 1, 2016, for a business insurance policy that is effective for only one year beginning on July 1, 2016. The 12-month rule applies. Therefore, the full $10,000 is deductible in 2016.”

Therefore, you may be able to deduct those prepaid expenses sooner than later.

Posted in Deductions

Deducting Vehicle Expenses

When it comes to taking deductions for your business vehicles, you can either use the standard mileage deduction or the actual expenses, but not both methods.

Standard Mileage Rate

With the standard mileage rate, you take a mileage deduction for a specified number of cents (determined by the IRS) for every business mile you drive. To figure out the deduction, multiply your business miles by the applicable standard mileage rate.

The standard mileage rate requires you keep track of how many miles you drive for business and the total miles you drive. You also need the date of the trip, your business destination and business purpose.

If you choose the standard mileage rate, you cannot deduct actual car operating expenses. That means you can’t deduct maintenance and repairs, gasoline and its taxes, oil, insurance, vehicle registration fees nor depreciation.

Generally, you’ll be better off using the standard mileage rate if you drive a smaller, old or an inexpensive car, particularly if you drive many business miles.   This is because you get the same fixed deduction rate no matter how much the car is worth. Because the standard mileage rate factors in depreciation, an inexpensive car might benefit more from it than an expensive vehicle

Actual Expenses

Instead of using the standard mileage rate, you can deduct the actual cost of using your car for business, plus depreciation. This requires much more record keeping , but you can potentially get a larger deduction with the actual expense method.  This method requires you keep detailed records of every single expense.  You’ll want to keep careful track of all the costs you incur for your car during the year, including:

  • gas and oil
  • repairs and maintenance
  • depreciation of your original vehicle and improvements
  • car repair tools
  • license fees
  • parking fees for business trips
  • registration fees
  • tires
  • insurance
  • car washing
  • lease payments
  • towing charges
  • auto club dues.

 

The actual expense method will likely provide a larger deduction if you drive a larger, more expensive car or don’t have a lot of business miles per year.

Which Method To Choose

The only way to know for sure which method is best for you is to keep careful track of your costs the first year you use your car for business. This means tracking your mileage and your actual expenses.  If you do this, then at tax time you can compare which method gives you the higher deduction

You can only make this comparison and choose the method to use the first year you use your car for business. After that, you’re ability to choose which method is subject to restrictions.

If you use the standard mileage rate the first year, you can switch to the actual expense method in a later year.  Then, you can switch back and forth between the two methods after that, subject to certain restrictions.

Conversely, if you don’t use the standard mileage rate in the first year, you have to stay with the actual expense method in future years.

Therefore, if you’re not sure about standard mileage rate vs actual vehicle expenses, it’s a good idea to use the standard mileage rate the first year you use the car for business. This leaves all your options open for later years.

Posted in Deductions

Employee Bonuses and Gifts

You can deduct the cost of tangible gifts you give to employees as long as the value does not exceed $25 per year per employee. They qualify as business expenses, and the gifts are not taxable to the employees or subject to withholding.

Cash — or cash equivalents, such as gift certificates — are looked at differently through the tax authorities’ eyes, however. You must treat such gifts as additional compensation, no matter what the amount. These gifts are subject to withholding and need to be run through payroll.

Per the IRS, “You can deduct no more than $25 for business gifts you give directly or indirectly to each person during your tax year.”

Posted in Deductions

Worker Classification

While the definition of employment in Colorado law is broad and inclusive, it is not the same as the Internal Revenue Service.

According to Colorado law, the two main concepts used to determine the status of a worker and whether they are an employee (W-2) or a contractor (1099) are:

  • Whether or not the individual is free from control and direction in the performance of the service, both under the contract for the performance of service and in fact.
  • Whether or not the individual is customarily engaged in an independent trade, occupation, profession, or business related to the service performed.

The more freedom an individual has to perform the job and the more they do similar work for other businesses, the more likely they are to be considered a contractor.

Some examples of these circumstances may include any written agreements that are in existence, the day-to-day relationship between the worker and the company, the actual directions given, the use of tools, advertising, type or payments and a myriad of other everyday issues. Overall, it is the totality of circumstances that is the basis of the decision.

Posted in Colorado

Can I pay someone as both an employee and as an independent contractor?

The official IRS position is that “facts and circumstances” always dictate how a worker is “classified” for employee (W-2) or independent contractor (1099) purposes. A person can be both an employee and an independent contractor if their “sideline services” are not part of their regular job duties. We have read that issuing both a W-2 and 1099 in the same time period to the same individual can cause a “red flag” to the IRS, but it doesn’t necessarily mean that a client will be selected for an audit.

The Federal Tax court case, Ramirez V. Commissioner, stated “that the fact that a person is an employee in one capacity does not foreclose the possibility that he can be an independent contractor with the same employer in another context”.

Examples of people who correctly should be given both a W-2 and a 1099 in the same year are:

–An employed dental assistant asks if she can clean the dental office on the weekend. She is paid a fixed weekly fee, uses her own supplies, and chooses the time from Friday PM to early Monday AM to clean the office.

–An employee of a surveying firm bids to provide lawn mowing services for his employer’s office building as part of his separate side business.

–A store manager is a musician and is paid to perform at the employer’s Christmas party.

To further solidify the relationship, we suggest having individuals sign an employment agreement for employee duties and an independent contractor agreement for other duties.  This could help solidify the working arrangements if the IRS ever comes knocking.

Posted in Tips

Are Tips and Gratuities Subject to Sales Tax in Colorado?

Tips and gratuities are payments that are separately paid to someone providing a service.

NOT TAXABLE

Tips and gratuities are NOT subject to sales tax when they are left on the table or location where the service took place or when they are added to the charge receipt after the price and tax are calculated.

Tips and gratuities are NOT subject to tax for the business when ALL of the following apply:

1) Tips/gratuities are separately stated on the bill and are OPTIONAL for the customer.

2) No portion of the tip/gratuity is retained by, or for the profit of the business.

3) Tips/gratuities are given to the persons providing the service.

For a large group, if the tip is separately stated and meets all of the above requirements and the customer has the option NOT to pay the tip, the tip should NOT be included in the sales tax calculation.

TAXABLE

Sales tax must be paid on tips and gratuities that ARE included in the cost of food served by restaurants, banquet facilities, hotels and caterers, or in the cost of services provided. Tips and gratuities ARE subject to tax when:

  • they are not separately stated, OR
  • they are collected by the employer and distributed as wages, OR
  • any portion is retained by the business, OR
  • the business uses them to compensate other persons and NOT the service providers.

If a restaurant or other business is providing services for a large group and the tip (gratuity or “service charge”) IS included in the charge, the tip MUST be included in the sales tax calculation

Posted in Colorado

Worst Part of Owning a Business

“40% of small business owners say bookkeeping and taxes are the single worst part of owning a business.”  Source: 2014 survey from SCORE, a small business mentoring organization

Posted in Quotes

Can I claim the home office deduction if I don’t own my home and pay rent?

You can claim the home office deduction whether you rent or own your home.

There are two options.  You can use a simplified option which is the square footage of the office times $5.  If you use the regular method, part of the rent you pay may quality.

If you are self-employed, you can claim the deduction on Schedule C as part of the P&L for your business.

If you are an employee, you can claim the deduction on Schedule A if you itemize your deductions.

Posted in Deductions, IRS

Home Office Deductions

The home office deduction is a great benefit for home-based businesses.  In 2013, more than 3.4 million taxpayers claimed deductions for the business use of a home.

In order to claim the deduction, the IRS requires that the home office be used regularly and exclusively for business, and the limit is tied to the income derived from the particular business. Business expenses unrelated to the home, such as advertising, supplies and wages paid to employees, are still fully deductible.

Self-employed individuals claim the home office deduction on Schedule C, farmers claim it on Schedule F, and eligible employees claim it on Schedule A.

There are two options: the simplified method or the regular method.

  • Regular Method
    • The home office deduction includes certain costs that you paid for your home. For example, if you rent your home, part of the rent you paid may qualify. If you own your home, part of the mortgage interest, taxes and utilities you paid may qualify. The amount you can deduct usually depends on the percentage of your home used for business.
    • Home-based businesses are required to fill out a 43-line form (Form 8829) often with complex calculations of allocated expenses, depreciation and carryovers of unused deductions.
  • Simplified Method
    • It is designed to reduce the paperwork and recordkeeping burden for small businesses.
    • The maximum is $1,500 per year, based on $5 a square foot for up to 300 square feet (make sure you only count the square footage that is used for business).
    • Using this method you cannot depreciate the portion of your home used in a trade or business, but you can still claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions on Schedule A. (These deductions need not be allocated between personal and business use, as is required under the regular method.)

You only need to complete a short worksheet in the tax instructions and enter the results on the tax return.

Posted in Deductions, IRS

Records Retention for Businesses

We are often asked, “How long do I have to keep this stuff?”

Whether personal or business, the minimum is 3 years to retain records since the IRS generally has 3 years to audit you from the date you file your taxes (with the exceptions of a false return or willful attempt to avoid tax).  However, the general rule is 7 years for records retention.  We generally use 10 years.

Scanning and creating electronic versions of your backup information helps to cut down on the paper pile.

Contact us if you’d like a more detailed guide for keeping all that “stuff”.

Posted in Tips