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Employees or 1099 Independent Contractors?

Mon, 19 May 2025 00:31:46 GMT

The relationship a business has with its employees is quite different compared to its relationship with independent contractors.

There are a couple of ways to look at this question. IRS rules are fairly clear, but there are also employment laws on the matter. This article will comment largely on the tax side of this question.

The relationship a business has with its employees is quite different compared to its relationship with independent contractors. Distinct advantages and disadvantages exist for both options depending on the type and amount of work that is desired to be accomplished.

Behavioral Control

One of the big differences that the IRS dictates between an employee and an independent contractor is behavioral control. If the employer trains and directs the work, including hours of work, what tools or equipment to be used, where the work is to be done, specific tasks to be performed, and how the work is to be done, the worker is probably an employee. If the worker can set his or her own hours and works with little or no direction or training, he or she is probably an independent contractor. In short, an employer has a lot more control over employees while independent contractors have a lot more independence in how they accomplish the tasks given to them.

Financial Differences and Control

The financial treatment of both parties is also very different. Factors such as the extent to which the worker has unreimbursed business expenses, the extent of the worker's investment in the facilities or tools used in performing services, the extent to which the worker makes his or her services available to the relevant market, and how the business pays the worker are all major factors to determine whether a worker is an independent contractor or employee.

When the worker gets paid is also different depending on if they are an employee or an independent contractor. An employee has a regular payment schedule that usually ranges between once a week to once a month and is paid at an hourly rate or salaried amount. Independent contractors can work at rates of per hour, day, week, or be paid one amount for the completion of the job.

Regulation and Benefits

A considerable difference between employees and independent contractors is that employees have various federal and local statutes and policies related to employment and labor that protect them and govern how they work. Independent contractors are not governed/protected by the same employment and labor laws.

Depending on the position they hold, employers often offer benefits to employees that independent contractors do not have access to. These benefits include pension plans, insurance, sick pay, and vacation pay. These benefits, along with payment plans such as 401Ks, can incentivize employees to stay with the company for long periods of time and increase satisfaction of the workers. When considering which you should hire for your business, benefits are an element to keep in mind.

Type of Relationship

The type of relationship can help determine if a worker is an employee or an independent contractor. If the worker is doing work that is a primary, ongoing function for the business, that worker should be an employee. Employees should be treated with a sense of longevity while independent contractors on a more situational basis, work that will mostly not be overseen directly by the employer.

What is the worst thing that can happen?

If you misclassify what should be your W2 employees as 1099 independent contractors, you are opening yourself up to a potentially significant liability. The IRS and other various state tax agencies will reclassify what you have paid to your independent contractors as wages and will make you responsible for all unpaid payroll taxes. They will most certainly tack on penalties and interest, they can go back several years and demand everything immediately.

I have seen firsthand a situation where a local construction company chose incorrectly and was handed a tax bill in excess of $100,000 by the IRS for their violation. They soon went out of business - there have been many others caught in the trap of this business killing mistake.

Conclusion

If you are going to pay anyone as an independent contractor, please make 100% certain your decision will be compliant. Is it really a risk worth taking if it could put you out of business?

If you need help navigating the IRS compliance for your business, we are happy to help.

The link to IRS website with supporting documentation below.

https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee

How Much Should You Pay Yourself as a Business Owner?

Mon, 19 May 2025 00:31:46 GMT

An entrepreneur needs to examine many relevant factors to determine when and how much they should pay themselves to optimize their company and themselves for success.

When you open a new business, a lot of money goes out for start-up expenses that you attempt to replace with revenue coming in. While we may all dream of paying ourselves high salaries from the start, this is typically unwise when the company is in its infancy. An entrepreneur needs to examine many relevant factors to determine when and how much they should pay themselves to optimize their company and themselves for success.

Taxes

A major expense to consider is the government’s reach into the business in the form of taxes. Many factors determine exactly how much your company and you, as an employee for that company, will be taxed. The goal is to optimize both your personal income and your company’s income to practice tax avoidance. Healthy reminder: tax avoidance is legal and can put yourself at a tax advantage while tax evasion is illegal.

Not understanding how your business entity will be taxed before deciding when and how to pay yourself can set you up for a huge surprise at tax time. Some businesses pay their own taxes, other’s do not, instead the income from the business passes through to the owner(s) individual tax returns. Some businesses expose the owner(s) to a 15.3% self-employment tax, others do not.

Do you know how your business is taxed? Do you understand the individual implications of how your business is taxed?

Pay Yourself as Early as Possible

I am a firm believer in business owners paying themselves something as quickly as possible. The amount doesn’t have to be large initially, but it should certainly be something. Depending on your business entity type, a reasonable salary might even be required.

All new businesses have a revenue, cash and sales problem when they start out. Growing sales immediately is the first real challenge, having yourself on the payroll gives you a regularly scheduled expense that you have to work to meet. You better get used to it – being successful in business is largely about fulfilling obligations.

There are stories out there about entrepreneurs who went XXX years without paying themselves a red cent, well good for them. I have seen plenty of cases you won’t hear about where a business owner didn’t take care of their personal financial responsibilities in the name of ‘growing the business’ – the result in almost all cases was loss of business. If you have revenues coming in, then you should be able to pay yourself something.

Pay Yourself a Living Wage

When you open a new business, it is important to keep in mind that you keep reinvesting money into the company. Once your company starts producing revenue, allocate a percentage of your revenues to owner pay. Keeping money consistently flowing into the company is essential to the growth of a company.

What is important is that you pay yourself enough that you can meet your living expenses. You may want to make more frugal choices to reduce your living expenses early in a business, but not paying yourself at all and draining your savings is a scary way to live.

Making some obvious sacrifices such as forgoing eating out and other luxuries would be wise in the event you are going to or have recently started a business. Putting yourself in a position where you cannot meet your personal financial obligations is typically not recommended. I haven’t met many people who can operate at a high level professionally while under the thumb of individual financial failure.

Conclusion

The most important idea that you should take from this article is to consider what is best for your company AND your household. You have to look after both if you want a successful business that withstands the pressures of the first 2-3 years.

Optimizing your company and personal finances to give yourself a tax advantage, paying yourself regularly, and paying yourself enough that you meet your standard living expenses puts you in a better position to run the company effectively. Give your company and yourself the best opportunity to survive your ramp up period.

Is Bookkeeping Really Important For My Business?

Mon, 19 May 2025 00:31:46 GMT

Unless you plan to wholly bootstrap your business endeavor from start to finish and never need any outside capital like a line of credit from the bank, you are going to need a set of accurate books.

If you are a new business owner, you may question if the benefits of bookkeeping are worth the hassle and time commitment. Every business owner is required by law to keep a complete and organized set of books and records, but the government and its regulations should not be the only reason that you keep accurate records. Here are a few reasons why accurate bookkeeping is really important:

Better Financial Records

Good bookkeeping gives you more accurate financial records. This is essential if you want to keep your business as profitable as it can be. Knowing each source of revenue and every cost and having those numbers quantified allows you to fully know the true financials of your business. More accurate records also prevent the likelihood of making mistakes that will be detrimental to your company.

Better Able to Make Sound Business Decisions

By constantly looking over your accurate and up-to-date financial records, you are able to make better educated business decisions. Through successful bookkeeping, you are able to act according to the numbers that you likely would not have known otherwise. If a source of income is generating more costs than revenue, it means you should turn your attention to turn that source more profitable or to shut it down.

Separation of Personal and Business Funds

Not separating personal and business funds causes many businesses to be penalized by the government because of the mistakes made based on the mixture of the two. Missed deductions and penalties are preventing you from making your company as successful as possible. By keeping your personal and business funds separate through accurate bookkeeping, you prevent the possibility of losing everything in your personal account to business expenses as well as make your company more likely to be profitable.

Necessary for Capital Needs

Unless you plan to wholly bootstrap your business endeavor from start to finish and never need any outside capital like a line of credit from the bank, you are going to need a set of accurate books. We see small businesses every day who are struggling to obtain the business financing they need because lenders cannot accurately ascertain how the business is performing.

Prepared for Audits by IRS

Should you get the dreaded notice from the IRS that you are being audited, it is going to be important that you have accurate books. If you are not able to present the information that they request, your business will only be hurt further by the IRS requiring more money from you and/or your business. If your books and records were not accurate, then it is almost certain your tax returns were no accurate. This can lead to a series of costly mistakes that often surface at the worst possible time. Is there ever a good time to find out you owe more money to the IRS in taxes?

Conclusion

Accurate and up-to-date bookkeeping is paramount to running a successful business. If you are a business owner and are failing at keeping these types of records, it may be best to look for an external service that can help you out. With good bookkeeping, you have more accurate financial records, are better able to make sound business decisions, access needed business Capital, ensure that your business and personal funds are separate, and are prepared with accurate tax returns in the case you get audited by the IRS. With proper bookkeeping you are increasing your business’s odds of success and adding a level of transparency your business performance.

What is Self-Employment Tax?

Mon, 19 May 2025 00:31:46 GMT

There are perfectly legitimate strategies in place to take some of the burden away from the self-employment tax, but avoiding this tax shouldn’t be the only reason you consider some of these changes.

Being self-employed has many wonderful benefits – setting your own schedule, controlling your own income potential, selecting the clients with who you wish to serve, being your own boss, the list goes on and on. But if you are going to be self-employed, then you may have to pay self-employment taxes in addiiton to your Federal and State taxes. Throughout this blog, we will discuss what is self-employment tax and how it could affect you as a business owner or independent contractor.

What is Self-Employment Tax?

In 1954, the government passed SECA (Self-Employed Contributions Act) to ensure that business owners were paying their fair share into the Social Security pool. Under SECA, business owners pay both ends of the tax, employer and employee. After Medicare became law, it was added to the self-employment tax as well. Employees typically have their portion held from paychecks, with the employer matching. These are now known as FICA taxes.

What is the Rate?

The self-employment tax is broken down into two parts. 12.4% of the tax goes towards social security, which covers retirement income, disability and even some survivor income for family of the deceased. This percentage is usually capped at applying to a certain amount earned. In 2017, this amount was $127,000, meaning you would only pay the social security portion on the first $127,000 earned. The remainder of the tax, 2.9%, goes toward Medicaid and has no cap, meaning it is paid on every dollar of income.

Who Must Pay Self-Employment Tax?

Many types of small businesses and almost all independent contractors get stuck paying this self-employment tax and it can really add up. If you have $50,000 of net business income after deductions you would be facing a self-employment tax bill of $7,650! This would be on top of your normal federal and State taxes. There are still employers who selfishly miscalssify their employees as 1099 contractors, often leaving them with large and unplanned tax bills.

What you can do about self-employment taxes?

There are perfectly legitimate strategies in place to take some of the burden away from the self-employment tax, but avoiding this tax shouldn’t be the only reason you consider some of these changes. Many small business will organize as a Corporation or elect to be taxed as an S-Corporation, which can have many other benefits to how your business operates and is taxed.

Conclusion

If you are now going to be self-employed, paying the self-employment tax will now become a part of your yearly duties. Understanding what the tax is, if you have to pay it, and when you should pay it are fundamental in making sure that your business meets all IRS requirements if you are a business owner. If you are reading this wondering if you have possibly been paying more than you need to in self-employment tax, we would be happy to start a conversation today to see what options you may have.

Type of Business Financing Available

Mon, 19 May 2025 00:31:46 GMT

There are options for businesses of virtually all sizes and stages, but there is a unique cost which comes with each type and variety.

Whether your business is relatively new or has been around for decades, there is a more than fair chance that the need for outside capital has come up at one point or another. Whether it was short-term capital needed to undertake a large project, or long-term financing needs for new equipment or even a business acquisition, the eventual need for outside capital for continued business growth is a very real concern for many small and medium businesses.

The reasons a business can need outside capital are endless. The types of capital and sources available in the market are plentiful, you may not even be aware of some of the many options. Navigating them can be admittedly painful, frustrating, and confusing. If the person you are speaking with represents some but not all of the various options, which will often be the case, you are likely to get a biased opinion of what is best for you and your business.

The purpose of this article is to inform you of some of the various options available, not to endorse any particular products. All capital products exist for a reason, they just may not make sense for your particular situation. Understanding what is available can help you make more informed decisions for your business.

Most all financing needs can fall into one of two buckets, debt or equity. Debt financing comes in the form of borrowing capital from a given source with the requirement of paying back the principal borrowed over time with interest. Equity financing involves the sale of ownership interest in exchange for capital. Hybrid financing combines two or more financial instruments and will carry characteristics of both debt and equity financing.

Types of Debt Financing

Bank and Credit Union lending – Most of you are likely familiar with these types of loans. These are term loans where a set amount is borrowed to be paid back over a set period of time. Typically, you would need some type of collateral for these types of loans or must have a track record of strong financial performance in your business. You will often be required to personally guarantee the loan, meaning you still owe it personally if the business fails. For a startup business, traditional bank financing can be difficult or impossible to obtain.

Trade credit – Many businesses must buy from suppliers routinely as part of their business model. If so, then trade credit from those suppliers can be a viable financing option. Trade terms can vary, but 30, 60, and 90-day trade accounts are the most common. This allows time to obtain your supplies, perform your service, or sell your products, and then collect from the customer before the payment to suppliers is due. Many suppliers will offer discounts if paid early.

Receivables Factoring – If you sell to your customers on credit, then you will carry an accounts receivable balance. Factoring is a service where a company will buy your receivables from you at a discount; then they will collect the amounts due from your customers. Not all factoring companies are the same and neither are the terms under which they operate. In some cases, if the invoice is not paid by the customer to the factoring company, you can be forced to repurchase the unpaid invoices. Another potential caveat is now having an outside company contacting your customers for payment.

Borrowing from Family/Friends – Borrowing money from friends and family is certainly an option that many startups have used. The terms can be more flexible than traditional banking, but then again, you need to know someone with the capacity to make the loan. As such, this may or may not be a good option for many small businesses.

Credit Cards – Early on, many small businesses utilize credit cards. While the rates on these cards can be much higher than traditional bank financing, obtaining them early on in your business may be substantially easier. Many cards will give you intro rates for the first 12-18 months, letting you take advantage of low or even zero interest rates. You may or may not have to personally guarantee the credit card debts as the owner.

Types of Equity Financing

Individual Investors – This could involve reaching out to family and friends or possibly another wealthy individual in your circle of influence. Depending on the size of your capital needs in relation to your business performance, you may have to give up a higher percentage of your equity than desired. Finding individual investors can be quite the difficult task, but this technique has been a very effective one for many fledgling businesses.

Crowdfunding – This is essentially when a group of investors pools their funds to buy equity (and sometimes debt) stakes in businesses. The types of investors allowed into these crowdfunding pools are more flexible than in the past as recent legislation has opened the door to this type of investment to over 300 million potential investors.

Angel Investors/Venture Capital – Both of these types of equity financiers tend to come in during the early stages of a business and serve startups as opposed to seasoned businesses. Angel investors are typically individuals or small groups of individuals lending smaller amounts (less than $1 million) of capital in exchange for shares of equity. Venture capital funds are more formalized groups of investors, often limited partnerships. Also referred to as VC, venture capital typically comes into play later in the business cycle of a startup than angel financing, often with amounts starting out at $1 million. Venture capital will typically, but not always, seek a defined return over a defined period of time, and equity can be repurchased from the VC firm at that time.

Private Equity – Private equity can be very similar to Venture Capital in many ways, but a key distinction is that private equity is not wholly focused around the startup business community. There are over 1,000 private equity funds serving a variety of capital needs in various industries for all stages in the business cycle. A popular misconception about P.E. (Private Equity) is that the only purpose is to purchase 100% of a company’s equity with the sole purpose of restructuring and selling at a gain. While some funds may be designed for this, it is incorrect to assume all operate in this manner. Many will buy less than 100% of the Company equity and will keep the existing management team in place with the goal of aligning their interests with ownership and management to increase company valuation. Some P.E. funds require the eventual exit of existing ownership while many others do not.

Types of Hybrid Financing –

The types of hybrid financing available continues to evolve as business needs change. Hybrid financing is a combination of financial instruments using some debt and equity components. One example of this would be convertible debentures. A debenture is merely an unsecured loan. A convertible debenture might issue capital in the form of a short-term loan with the option to convert to shares of equity if the principal is not repaid under the agreed upon terms. Another common type of hybrid financing are preferred shares of equity. Preferred equity stakeholders get paid before common equity stakeholders. If there are not sufficient profits to satisfy the preferred dividends, then the unsatisfied amounts can become debt owed in a future year.

It would be impossible to list all of the various types of hybrid financing available in this post as new concepts and ideas are constantly hitting the markets. Some types never pick up steam while others are used to fill in gaps to move deals forward, aligning the objectives for investors and borrowers.

This is merely a surface level view of the various types of business financing available. You can certainly take a much deeper dive as there are businesses entirely focused on helping business borrowers navigate the various capital raising options. There are options for businesses of virtually all sizes and stages, but there is a unique cost which comes with each type and variety. It stands to reason that the riskier the loan is for the debtor, the higher the interest rate you will be paying. Equity almost always costs more than debt, as you are giving up a piece of future growth. Hybrid financing can often give options to the borrower to absorb costs in the form of debt instead of equity.

How Will the New Tax Bill Affect my Business?

Mon, 19 May 2025 00:31:46 GMT

The more confusing the tax laws are, the more difficult they are to comply with. This makes the task of an IRS examiner much easier as the likelihood of errors being present is much higher.

As most of you are likely aware, the Tax Cuts and Jobs Act was signed by President Trump and became law in December of 2017. There has been no end to the debate as to whether or not the changes will benefit individual taxpayers, as tax situations can vary so greatly from one family unit to another. Opinions among business owners also seem to vary, though there has been a shroud of mystery for many as to how these changes affect their businesses.

The National Association for the Self-Employed (NASE) has said that 83% of small business owners do not fully understand the potential impact of these changes to their business. They also have shared that 90% of small business owners don’t believe they have been properly advised and prepared for these changes by the Government.

While the ultimate goal of lowering tax liabilities appears to have been accomplished, the overall tax system has not really been simplified to the extent it is easily understandable for most business owners. Hopefully this article can shed a little light on how your business may be affected and give you some confidence on what March 15th and April 15th of 2019 will mean to you.
Before diving into the changes, it probably makes a little sense to explain the different types of taxable entities and understand how your business is taxed.

Corporations – A popular misconception is that all corporations are gigantic businesses like Amazon, Google, Apple, or Wal-Mart. This simply is not true. We advise plenty of Oklahoma City area clients who own corporations doing well under $1 million in annual revenue. Corporations pay taxes on their net income (revenues minus deductible expenses) just like an individual would.
The corporate income tax rate was at a rate of 35% for roughly 35 years, since the Reagan-era tax cuts were put into place. The biggest change for Corporations under the new tax law is the rate itself, which was lowered from 35% to 21%. This amounts to massive tax savings for corporations. How this impacts the economy remains to be seen, but many corporations have already committed to repurpose those tax savings into various forms of business investment.

Pass-Through Income Entities – 95% of US businesses fall into this category, which means the business’s net income actually ‘passes through’ to the owner’s individual tax returns. Sole Proprietorships, Partnerships, and LLC’s all fall into this category. The entity itself will not have a tax liability, but the owners of these entity types will.

Included in the new tax is a potential 20% deduction of the Qualified Business Income (QBI). QBI will typically be the business’s net income. Unfortunately, this 20% deduction is neither absolute nor guaranteed, and its complexity is a hotly debated topic halfway into the 2018 tax year.
Because this 20% deduction provides opportunities for many businesses to ‘game the system,’ a series of relatively complex checks and balances have been put into place. These potential obstacles for taking the deduction can vastly change the game as the size of the deduction will vary depending on the nature of the business as well as the total income of the owners.

Yes, you read that correctly, certain business types will be taxed differently than others after applying the QBI Deduction. Some companies are designated as Professional Service Companies. Examples would be lawyers, doctors, accountants, professional athletes, business consultants, and financial advisors. Owners of these business will begin to see their QBI deduction phased out at a combined income of $315,000 for a married couple or $157,500 for single filers. The QBI deduction for these companies will be completely phased out at married income of $415,000, or single filer income of $207,500.

Owners of other businesses like plumbers, electricians, mechanics, roofing contractors, and homebuilders would not see their QBI deduction phased out. While this does not seem fair or follow any logic I can see, it is now the law of the land.

Specifically, the verbatim guidance provided on what is a professional service company at this point is as follows:
“Any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its employees or owners.”

Because this is all so fresh, there is little guidance provided and no case law precedents to refer to. Loss of the QBI deduction could amount to loss of potential tax savings of $15,000 - $30,000 or even more in some cases.

A self-employed plumbing contractor who is taxed as an S-Corporation and makes $400,000 will absolutely pay more in taxes than a self-employed dentist who makes the same. This could open the doors for getting deep in tax planning for the professional service company owners who expect to be or are already higher earners.

Confused yet? I am fairly certain this was by design. The more confusing the tax laws are, the more difficult they are to comply with. This makes the task of an IRS examiner much easier as the likelihood of errors being present is much higher.

If you are confused by how the new tax law may affect your business and your family’s bottom line, it is highly recommended you sit with your preferred tax professional as soon as possible.

Why Small Businesses Should Utilize Expense Reimbursement: An Accountable Plan Worth Having

Mon, 19 May 2025 00:31:46 GMT

One powerful tax planning tool for many small businesses that is often overlooked is the use of an accountable plan for expense reimbursement.

One powerful tax planning tool for many small businesses that is often overlooked is the use of an accountable plan for expense reimbursement. Without getting too complicated, it is essentially a plan where employees of a company can be reimbursed by the company for valid business expenses.

This is a common arrangement when between employers and employees; many of you reading this may have worked somewhere with a plan like this in the past. You bring in receipts from your business conference, you in turn get reimbursed for those expenses. If IRS conditions are met, the reimbursement is not taxable to the employee but is deductible to the business.

This common arrangement is often overlooked and underutilized in small business planning. Many small businesses have elected to be taxed as a Subchapter S-Corporation, which means owners are often shareholders and employees. With the company being a distinct entity, there is an opportunity to utilize reimbursements in certain instances. Of course, getting money out of the business without creating a taxable event is always a challenge.

Automobile Mileage Reimbursements
Many small businesses are most likely familiar with deducting the standard mileage rate ($0.545 for 2018 per mile). Twenty thousand business miles could be a $10,900 tax deduction. Depending on your marginal tax rate, this could be saving you roughly $1000 - $3500 in federal tax liability (tax rates vary from 10% to 37%). A reimbursement for business miles used on a personal vehicle could be more impactful for this taxpayer. The reimbursement of $10,900 would allow for the non-taxable transfer of $10,900 from the business account to the personal account. The reimbursement is not taxable to the taxpayer (the employee) but is deductible to the Company (also owned by the taxpayer).

A question I always ask my clients or someone looking for tax consultation is “would you rather save a couple thousand in taxes, or get a non-taxable check for $10,900?”

Home Office Deduction
Many small business owners may utilize a home office. Many have been told they cannot take the home office deduction if they own a business, but this doesn’t mean a reimbursement can’t be achievable. Similar to the auto example, let’s say the home office deduction was $2,000 for the year. This may result in tax savings of $200-$740 depending. The reimbursement of the same $2000 results in a non-taxable transfer of funds. Would you rather save a few hundred in taxes, or get $2,000 non-taxable check?

In both instances, we are talking about mixed-use expenses or things that are some business use and some personal use. 100% business should be paid from business funds, 100% personal should be paid from personal funds.
Other potentially reimbursable, mixed-use expenses – Home internet, cell phone, tools, and equipment.

IRS conditions include:
• Expenses have a valid business connection.
• Proper substantiation – expense reports – receipts, mileage logs, etc.
• Return of excess – excess reimbursements must be returned, or they become taxable to the employee and must be included on the W2 at year-end.

I highly recommend that most, if not all business owners, should utilize an accountable plan. If your plan is challenged by the IRS, you will need to be able to show your plan followed the parameters and can demonstrate the enforcement through accurate records.

Do you plan on leaving money on the table in your S-Corporation in 2019? Feel free to reach out to our CEO, Josh Morphew – josh@insightful.tax, to schedule a free consultation.

Cash vs. Accrual Basis Accounting: What’s Best for Your Small Business?

Mon, 19 May 2025 00:31:46 GMT

Whether you decide to outsource your financial reporting to an accountant or CPA, it is still crucial for you to understand both of these methods.

As a small business owner, you most likely are aware of the two most common methods of accounting: cash and accrual. Whether you decide to outsource your financial reporting to an accountant or CPA, it is still crucial for you to understand both of these methods. If you are a new business owner and just getting started, then you most definitely want to learn the key differences between these two methods of accounting.

What is the Cash Basis?
On the cash basis, you recognize revenues when you deposit money (not when you invoice the client). For example, think of your younger self owning a lemonade stand in your neighborhood. You charged 50 cents for a cup of lemonade. One person pays you the money for the cup while another told you to stop by later in the week to collect the money. When adding up how much you made that outing, you only have 50 cents because that is what you actually have in hand at that moment.

Same goes when you pay vendors. You recognize expenses from vendors when you pay them (not when they bill you). An example of this would be when you receive your internet bill. You won’t actually see that money leave your account until you actually pay the bill.

What is the Accrual Basis?
The accrual basis is the complete opposite of the cash method. Income and expenses are recorded when they are billed and received, regardless of when the actual money is received. For accrual, you recognize revenue when you invoice the customer (not when you receive the money).

This also applies when you recognize expenses from vendors when you are billed (not when you actually pay them).

What’s Best for Your Small Business?
The most common accounting method used by businesses is the accrual basis method. The cash basis method is the easier of the two, since it’s pretty straightforward. The accrual method requires a little bit more bookkeeping due to the time it takes to record and track your income and expenses.

When it comes down to it, there are two sets of financials that are worth noting:
• Financial reports for internal management and external users (such as banks, investors, etc.)
• Tax reporting for the tax returns

You do not have to use the same method for each. In most cases, small businesses with less than $10M in sales will benefit on their taxes from cash basis accounting. By not having to report uncollected sales (accounts receivables) as income, there are usually some tax incentives, especially early on in the business cycle.

Cash basis accounting is easier for many people to wrap their heads around – simply match what is hitting the bank each month. Relying only on balance in the bank to gauge your business performance is not enough to get an accurate picture of how a company is performing. It does not factor in for money owed to the business or owed to others by the business.

In most cases, a company should be evaluating its performance using accrual basis accounting. Matching revenues and expenses to the period when they are earned (not necessarily received or paid) will give you a much clearer picture of how your business is actually performing.

Still not sure which is most suitable for your business? Here’s a quick guide of the advantages and disadvantages of both accounting methods:

Disadvantages
Cash Method
• Can falsely represent how a Company is really performing since it won’t show who owes you money and who you owe money to.
• Can sometimes save money on taxes early in a business with a larger cost in the future by being forced to switch methods.

Accrual Method
• More difficult to keep on the accrual basis. Increasingly so for certain types of businesses, such as construction contracting, field service companies, or manufacturing.
• More sophisticated accountants typically required, internally or externally.
• Accrual accounting can help identify relationships between revenues and expenses to model future financial outcomes, as well as the budget for future revenues/expenses.
• As your business grows, your lenders/investors will definitely want to see accrual-based numbers.
• Eventually, you may have to keep your tax records on the accrual basis as well.
• When and whether you should be doing this is a conversation you should be having early in the business cycle. Once revenues hit $10M, you are forced to go accrual for tax purposes and being caught off guard with this can have some surprising effects.

Advantages
Cash Method
• Easier to keep accurate – less skilled accountants can handle
• Often times results in lesser tax liability, especially earlier in business cycles and for companies who have more money owed to them than they owe vendors (receivables greater than payables)
• Easier to interpret for those without financial backgrounds or comfort

Accrual Method
• More accurate picture of real company performance – more useful for business analysis
• More useful in planning for the future – or for performance-based incentives within the company
• Going to be required in many instances for lenders/investors, bonding, insurance, etc.

Some small businesses can choose a hybrid of accounting, wherein they use accrual accounting for reporting and cash method for their income and expenses. If you’re unsure of which accounting method is the best fit for your business, feel free to reach out to me at josh@insightful.tax.

The Automobile Deduction

Mon, 19 May 2025 00:31:46 GMT

The simplest method for calculating your vehicle-related deductions is to use the standard mileage deduction. This method is pretty simple to use and, from my experience, is the right choice for 80-90% of the people I have visited with.

Certain expenses related to the use of an automobile for business use are deductible. How to treat auto expenses, whether for your business or as an employee using their vehicle for business, can be a powerful, tax planning tool.

Auto deductions can essentially take 2 separate paths – actual expenses or the standard mileage rate.

Standard Mileage Rate
The simplest method for calculating your vehicle-related deductions is to use the standard mileage deduction. This method is pretty simple to use and, from my experience, is the right choice for 80-90% of the people I have visited with.
You are eligible to count any miles you drive for business-related purposes. In 2018, the standard mileage rate was 54.5 cents per mile. With gas south of $2.00 here in Oklahoma City, that’s a nice-sized deduction. If you get 25 miles per gallon, then you get a $13.00 deduction for each gallon of fuel used.

In order to claim this deduction, you do need to keep a mileage log. Your mileage log should include the date, start time and end time, the activity involved, and the beginning and ending of odometer readings. If the IRS examines you, you can expect them to want to see validation of your mileage. There are plenty of apps and easy ways to do this now.

When using the mileage method, you don’t get to deduct any other automobile expenses. If you drive 10,000 business miles, then 10,000 x $0.545 = $5450 is your deduction. Once this method is chosen, you are not allowed to deduct any other expesenses. If you’d prefer to deduct other items, you need to use the Actual Expenses method.

Actual Expenses
This method can be more complicated. Instead of taking a mileage deduction, you would deduct the various actual expenses from the automobile usage, including:
• Gas and Oil
• Maintenance and repairs
• Auto insurance
• Auto loan interest
• Registration
• Depreciation

Depreciation is where this method can become a little tricky. Depreciation is how you recapture the expense of purchasing a vehicle. A vehicle purchased for $30,000 can be depreciated up to $30,000 over time. Purchasing an automobile for $30,000 doesn’t mean you get to deduct the whole $30,000 in one year, though in some cases you can. The type of automobile and even the amount you purchase the car are factors in what options you have in depreciating the vehicle.

ProRation of actual expenses – If the automobile used is not 100% business use, then you don’t get to use 100% of the actual expenses. For example, 50% business use means you get to use 50% of the actual expenses as the deduction. Business use % is often determined by miles.

Which is Better?
The Standard Mileage Rate method is better in the majority of instances, though certainly not in all. If you drive a vehicle 20,000 business miles and it was 100% business use, you would be looking at a mileage deduction of $10,900.

By using the actual expenses method, if you bought that same vehicle in the tax year for $40,000, you could depreciate that vehicle as well as the fuel, maintenance, and insurance expenses.

Can I switch methods?
In short, no. Once you pick a method, you are stuck with it. If you are a business with more than 5 vehicles, then you have to use actual expenses for those vehicles.

This article is intended to provide you with general information; it does not constitute any type of tax advice. The views expressed in this article are those of the author alone. For recommendations related to your overall financial and tax status, get in contact with our CEO, Josh Morphew – josh@insightful.tax.

Common FAQs

Mon, 19 May 2025 00:31:46 GMT

Without a doubt, the most common reason I have been given for the unfiled returns was the taxpayer not believing they have the funds to pay the amount due.

Should I file my tax return even if I don’t have the money to pay?

One of the most common tax problems I encounter is having unfiled tax returns. There are a lot of reasons why this happens, but many of them come from misconceptions held by the taxpayer. Without a doubt, the most common reason I have been given for the unfiled returns was the taxpayer not believing they have the funds to pay the amount due. Out of fear and hoping the problem could be dealt with later, the situation often snowballs and can end with you owing a lot more than you would have.

In almost every case, you should be filing your tax returns on time, whether you can pay what you will owe or not. There are many penalties you can be charged by the IRS, the highest of which is for not filing your return.

Up to 25% of taxes owed as Penalty for Failure-to-File your return

Failure to file your tax return on time, even one day late, will have a minimum penalty of 5% of the amount of taxes you owe. This means if you are one day late filing your return and owed $10,000, now you owe $10,500.

The penalty increases at 5% per month late until hitting a maximum of 25%. This means if you file your tax return late by more than five months and owed $10,000, now you will owe $12,500.

This is quite a steep and easily avoidable penalty. Can you imagine how easily this can pile up with multiple years of unfiled returns?

Up to 25% Penalty for not paying your taxes on time

Not paying your taxes on time carries its own set of penalties. While the penalty for not paying the tax can also be 25% of the amount of unpaid taxes, it accrues much slower, at 0.5% per month.

If you pay your taxes 6 months late, you are looking at a 3% penalty, and this is substantially less than the 25% penalty you would get on top of this if you also filed the return 6 months late.

How do Extensions affect the Failure-to-file and Failure-to-Pay Penalties?

Most people are away, and they extend their tax filing deadline by 6 months. By filing a simple form, you get an extra 6 months before your return is due.

What many people fail to understand is that the date your taxes were due to be paid does not get extended. Many taxpayers are surprised when filing – after their extensions – and paying their taxes due to receive letters from the IRS, demanding penalties and interest.

Are there any exceptions for these penalties if you file and pay late?

Yes, there are two main ways a taxpayer can get relief from these penalties.

1)The IRS will waive these penalties if there is a reasonable cause for not filing and/or paying on time.

There is a set of circumstances and situations provided by the IRS, where it will consider waiving these penalties. Below is a link to their website, where they discuss in detail the subject.

https://www.irs.gov/businesses/small-businesses-self-employed/penalty-relief-due-to-reasonable-cause

2)Penalty abatement - Even if there is not a reasonable cause for the delay in filing and paying your taxes, you may be able to get the IRS to abate (remove) some or all of the penalty.

If you have filed and paid on time the preceding 3 years, have currently filed all required tax returns and paid or made arrangements to pay all taxes due, then you can get a one-time abatement of penalty.

More information on penalty abatement in the link below.

https://www.irs.gov/businesses/small-businesses-self-employed/penalty-relief-due-to-first-time-penalty-abatement-or-other-administrative-waiver

Bottom line – it is much more expensive not to file your tax returns on time than it is not to pay them on time. Deal with getting them filed first; there are many ways to address paying the amounts owed over time. Don’t let a bad situation get worse.

If you have unfiled tax returns or are concerned about getting your taxes filed in time for the upcoming deadline, reach out to us today for a free consultation.

Are there Tax advantages in employing your School-age children in your small business?

Mon, 19 May 2025 00:31:46 GMT

Your children can actually earn up to $12,200 each as of 2019 without being subject to Federal income taxes. This provides a wonderful way to effectively take assets from the business into the family with an added tax benefit.

Employing your children in your small business can have many advantages. The potential for hands-on teaching, bonding, and countless other teaching/learning opportunities is incentive enough for many, but did you know there can be tax advantages from the family perspective as well?

Your children can actually earn up to $12,200 each as of 2019 without being subject to Federal income taxes. This provides a wonderful way to effectively take assets from the business into the family with an added tax benefit.
The business gets to deduct the payment of wages, but the recipient child may not have to pay any income on this income, keeping 100% of it within the family unit.

Be mindful, the $12,200 limit before income is taxable doesn’t apply only to the wages paid, but also if the child has other wages or even some investment income that counts toward that limit of $12,200. If they have more combined income than this, they will be subject to some income tax.

The reason for this is simple – All taxpayers get a standard deduction from their income of $12,200. If you make $12,200 or less, then your taxable income is $0.

Creating the income for your children shouldn’t be a sham or fake job, there really needs to be an employee-employer relationship. Remember, there are plenty of opportunities here to teach your children about the virtues of employment, getting something for nothing really isn’t one of them.

Using the money paid to fund a ROTH IRA can be another value-added strategy, while also teaching the virtues of saving for the future. The taxpaying child could let that money grow for 45-50 years until their own retirement age, and $1,000 invested at age 15 could be worth $20,000 - $80,000 at age 60, depending on the interest rate earned. ROTH IRA’s grow tax-free and come out tax-free, so you can create a powerful tool with exponential capabilities for your children.

If you would like to explore utilizing this family wealth creation strategy for your family, reach out to us for a free consultation. We can explain all of the ins and outs, and even recommend some financial advisors if you need help opening the ROTH IRA’s.

Myth #1: Filing Taxes

Mon, 19 May 2025 00:31:46 GMT

Any form of classified taxable income must be reported, and although this may seem involuntary, the action of filing taxes is prompted by individual free will.

Filing taxes is described as being a voluntary action, but its origins are uncertain, likely from a variety of resources and situations. The Form 1040 Instruction booklets use the term ‘voluntary’, but this does not mean that participating in the filing of taxes is voluntary. In light of this expression, many people have taken their opposition against this proclaimed voluntary action to the highest tax courts and have summarily found themselves facing steep fines and imprisonment. Individual taxpayers’ claims refute the necessity of voluntary action and make misinformed assertations that are eventually disproved by the Internal Revenue Service and government courts. These inappropriate contentions are subject to legal punishment and provide an example of dishonesty among some taxpayers.

The term voluntary, or voluntary compliance, refers to taxpayers’ abilities to calculate their own tax liability, rather than having the government do this for them. Of course, if what you report is disputed, then the IRS will calculate your liability for you and demand you pay the difference plus penalty and interest. Similarly, the description as voluntary refers to the voluntary compliance with the tax code that is evident by tax reporting and paying. Cooperation is described as the honest and accurate filing of annual tax returns. Any form of classified taxable income must be reported, and although this may seem involuntary, the action of filing taxes is prompted by individual free will. Further, accurate identification and information is required when completing income tax return forms.

As stated in the tax codes and laws, any taxpayer who has received more than a statutorily determined amount of gross income in a given tax year is obligated to file a return for that tax year. This means that with whatever taxable income is received and whatever kind of employment it is received through must be noted and used to file a tax return for that year. Many taxpayers participate in a form of tax fraud in order to reduce their income tax liability. This liability corresponds with the amount of taxable income that a recipient obtains during the tax year. In turn, these dishonest filers report no income and therefore no tax liability despite the existence of both. Filing a so-called zero-return while receiving a taxable income is considered an illegal action. Likewise, another method of manipulation is exhibited when taxpayers intentionally provide false information on their W-2 tax filing forms. The wrongful and inappropriate filing of taxes demonstrates dishonesty and noncompliance with the law which becomes problematic for the economy. Paid taxes are apportioned to different government institutions like police and firefighting units and to resources like the maintenance of road conditions.

A reported dispute, as mentioned above, is managed by the Internal Revenue Service, commonly called the IRS. Further, any taxpayer who fails to file a tax return will be penalized in a civil court or face criminal liability charges. In these instances, the IRS will prepare the tax returns on behalf of the individual. Another common contention against the IRS is the false belief that an administrative summons can be ignored and avoided. However, the IRS is authorizes to summon a taxpayer to appear in court to testify and provide documentation of taxable income. Many individuals also assert that any financial compensation received by an individual for a personal provided service is not taxable. However, taxable income includes any wages, salaries, bonuses, commissions, and tips received in exchange for any provided service, whether personal or professional.

Whether you agree with the taxation system or not, this is the current implemented law and the IRS is a collection agency that has an extraordinary power evident in the established tax codes and laws. The law compels individuals to voluntary file income taxes and provide verifiable personal information by threatening government penalization. Tax evasion and nonpayment can result in fines and often times imprisonment. Despite the establishment of these existing codes and laws, many senseless taxpayers search for loopholes in the system. They often suggest that taxation is not a mandatory responsibility since it is described as being voluntary. However, this is obviously a misinformed assumption. Taking a senseless tax argument to the courts is hence not recommended; history has demonstrated that the IRS has little tolerance for facetious oppositional tactics and prevails as the authoritative contender. Further, actively resisting and disregarding the law identifies an individual as a criminal whose taxes will continue to require monitoring and verifying in the future. Below is a link to the IRS guidance on and evidence against past frivolous tax arguments.

https://www.irs.gov/privacy-disclosure/the-truth-about-frivolous-tax-arguments-section-i-a-to-c#_Toc350157887

Myth Buster with Josh: Student Taxes

Mon, 19 May 2025 00:31:46 GMT

There is a wildly popular- and misinformed- belief that high school and college students and minors do not have an obligation and are not required to file and pay taxes. There are some truths to this particular assumption, however, it is not entirely accurate. There are certain minimum income and maximum age requirements established as to not wrongfully tax and impede on the financial situation of young individuals.

Being a full-time student is not a sufficient enough circumstance to completely exempt an individual from filing an income tax return. Any income received or finances used for tuition must be reported to determine if any federal taxes are to be paid or returned. Scholarships, grants, and fellowships are classified as tax-free resources if the amount received is used for tuition and supplies. Any portion of those resources apportioned to living expenses must be claimed. Often times college campuses will provide resources and consultations to help students file their taxes. Alternatively, online software is available as a quick solution for filing an income tax return.

There are many factors to consider when filing taxes while in college. The first step is to determine your dependency status; if you are claimed as a dependent by an adult you cannot make claims for yourself. Dependent status is typically dropped at the age of nineteen, however, parents can claim dependent children in college until they are twenty-four years old. As a dependent, there must be a clear distinction and no overlap between claims made by the parents and the individual. It is also important to know which tax forms are needed to complete an income tax return. W-2 forms can be obtained from an employer to indicate the amount of taxes withheld during the tax year. Tuition information is documented in the Form 1098-T, provided by the student’s college. Optional education credits such as American Opportunity Credit can be determined in the Form 8863. Lastly, the 1098-E form exists to show interest paid on certain student loans.

There exists a minimum income amount received by students that is necessary for the income to be subjugated to taxation. As of 2018, the standard deduction for all individuals is declared to be $12,000. This means that a received income of $12,000 or less will end up being non-taxable, and these students will be exempt from filing a tax return. The majority of students who work have some amount of federal taxes held from their checks. While they may not be required to file if make less than determined $12,000, they are not eligible to receive a refund for the amounts withheld from their paychecks. Filing is hence not mandatory but is often favored in instances where returned taxes are profitable.

Investment incomes available to minors and young adults are also subject to taxation. This income includes portioned amounts of money delegated in trusts and assets like estates, savings account, stocks, and bonds. Child income from interest and dividends of investment are also subject to taxation. If the child receives $2,100 or more in investment income they are required to file and may be subjected to the tax rates of their parents.

The taxation code in which part of a minor’s net unearned income can be taxed at the federal income tax rates is deemed the ‘Kiddie Tax’. However, this is an unfavorable tax because the trust and estate rates are unlike the rates individuals which can prove to be costly for minors without any earned income. The Kiddie Tax applies to individuals that are below the age of nineteen. Similar to the rules of student income tax return filing, college students under the age of twenty-four are classified under the Kiddie Tax and must report any of their unearned incomes.

The Kiddie Tax is calculated by adding the amount of unearned income to the amount of any earned income. The standard child deduction is then subtracted to determine the total amount of taxable income. This income is then taxed at regular rates if it exceeds the $2,100 income threshold. The Kiddie Tax is obviously inconvenient for individuals without any earned income. Consulting with tax professionals or college campus tax advisors is often beneficial in these situations to determine any available strategies available for reducing the burden of this tax.

Details of the aptly named ‘Kiddie Tax’ linked below:

https://www.marketwatch.com/story/new-tax-law-makes-dreaded-kiddie-tax-more-expensive-2018-09-24

Myth Buster with Josh: Married? File Separately to Save More Right?

Mon, 19 May 2025 00:31:46 GMT

Splitting the tax bill is also associated with tax liability between spouses. This is the most common reason why married couples prefer filing taxes separately.

The Myth

You save money on taxes if you file separately from your spouse.

Background Information

In practice, particular scenarios exist where one can save money on income taxes. An example of this is marriage.

For a couple to be classified as being married by the IRS, the following conditions must be met:

Couples must be lawfully married.
The couple must live together within the state.
They have yet to be officially registered as divorced due to a lack of maintenance forms or a final verdict.

The Truth

The origin of this myth can’t be pinpointed, but many believe it has probably gained prominence from a couple who were successful in reducing their tax costs through these means.

All married couples usually have the option of choosing a method for filing their tax returns—jointly or separately. The myth is that separating your tax filing returns will save you a lot, but this is not always the case. By filing separately as a married couple, you cut the deductions for IRA contributions while eliminating possible reductions, such as child tax credits and other tax breaks.

A partner may pay less to the IRS by filing individually when both spouses work and earn the same amount of money.If having compared the tax to be paid under separate and joint filing statuses, couples may discover that by combining their earnings, then they may fall in a higher tax bracket.

There are situations where the exception may be valid. One fact that remains is you will pay less in taxes filed jointly as a couple. In doing so, you lose certain credits and gain deductions, such as the child tax credit (CTC), adoption tax credit, earned income credit, student college tuition credits, or loan interest deduction.

Why couples prefer filing separately

Splitting the tax bill is also associated with tax liability between spouses. This is the most common reason why married couples prefer filing taxes individually. There are multiple valid, legal reasons why couples would want to split tax liabilities, especially when one or both spouses own businesses. There are also times when a spouse may be uncomfortable with the other’s tax principles and would prefer to safeguard themselves from potential tax complications; thus, filing separately can become an option.

If a divorce is being considered or pursued, however, filing separately will possibly minimize any complications with the IRS after the divorce has been passed.

Need for caution

While you look for strategies to reduce your income taxes, it is essential to be careful while taking tax advice from friends and family who are incompetent to do so. Even though the intentions are often good in most cases, one can still be misguided. They can cause you a lot of grief in the form of lost time, energy, and money.

Relying on advice from a cousin, for example, won’t get someone out of penalties from the IRS, since his or her advice may turn out to be inaccurate.

Myth Buster with Josh: Profit & Losses

Mon, 19 May 2025 00:31:46 GMT

It is possible to deduct any loss a business incurs from the income for that year, a common practice amongst most small business entrepreneurs.

The first point to note is that businesses don’t always earn profits. Suffering losses is common, especially amongst companies in their initial stages. Poor economic conditions are also significant contributors to business losses. If this happens, it’s just because of unfortunate circumstances. However, the silver lining for business owners who suffer losses is that they may receive some tax relief.

How it works
It is possible to deduct any loss a business incurs from the income for that year, a common practice amongst most small business entrepreneurs. It is common for business ventures to fail to make a net profit for long periods after startup. A famous example of this is Facebook, which was unable to make any profit for years, even after attaining a reputation as a multi-million-dollar corporation.

High-income earners are also looking for ways they can minimize their tax liability. Not every business income is similar. Therefore, they may consider some of the income to be passive while declaring other income to be active. However, each option has its own set of guidance, regulations, and rules.

If business losses exceed the income from all the sources in that year, it is defined as a net operating loss (NOL).Even though it is not desirable to lose money, a net operating loss helps to reduce the tax liability for the relevant year and the future. However, you cannot deduct what you have as a passive loss against your active income. Therefore, it is impossible to offset all of the business gains from the first business where they do not dedicate all their time.

If a business is operated based on a partnership or corporation model, an entrepreneur's share of the business' losses can be passed through the business to the individual's return. Hence, the losses are deducted from personal income using the same technique as with a sole proprietor.
On the other hand, if one operates the business as a limited company, business losses belong to the corporation, which means they cannot be deducted from a personal return.

If someone invests $50,000 in a business venture that fails after a while, then the losses will be limited only to the $50,000 invested. However, the losses that are in excess of the investment are not lost forever. They can only be carried forward to a time when the business will have an income to offset it. This type of scenario is generally experienced in the early stages of startup ventures.

In this case, some of the financial resources that business owners have used will be borrowed. This operation is performed such that their losses are found to exceed their initial investment from the shareholders. These losses cannot be deducted during that tax year, but they can be postponed for future benefits by offsetting income once the business becomes profitable. In fact, it does not make any sense for the losses to be deducted when the business is not stable for tax returns.

Myth Buster with Josh: Tax Liability

Mon, 19 May 2025 00:31:46 GMT

The bottom line is your tax liability is your tax liability.

Whose fault is it if your tax advisor files your taxes incorrectly?

In most all cases, you are responsible for what is on your tax return, whether you prepared it or not. There are a lot of assumptions taxpayers often make about what their accountant, advisor, or tax preparer is or isn’t doing for them.

I have met prospective clients who believe that the accountant is on the hook if the income and expense information they provided to them is found out later to be inaccurate by the IRS. This is not accurate, if information provided is inaccurate, that is on the taxpayer to remedy.

What happens if the error was the cause of an "honest mistake?"

I know people who became victims of honest mistakes on their tax returns who were greatly surprised when the IRS still expects them to pay the correct amount, even though they didn’t make the mistake. So maybe having Crazy Uncle Joe prepare your tax returns isn’t as safe as you thought?

What should business owners and individuals know about tax liability?

The bottom line here is that your tax liability is YOUR tax liability. There most certainly can be relief from IRS penalties if the mistakes resulted from relying on bad advice (such as from a tax preparer or even the IRS), but the income tax itself will still be owed.

This also doesn’t mean you have no recourse against egregious errors or gross negligence from the accounting firm who prepared the returns. In this case however, the taxpayer still owes the IRS and must separately take legal action to try and recoup from the offending party the damages they caused.

While we are not qualified to give legal advice in any way, but for more information on tax liabilities stemming from accountant errors, the following link might be helpful.

https://www.marketwatch.com/story/what-to-do-if-your-accountant-botched-your-tax-return-2018-04-05

Myth Buster with Josh: Retired People Don't Have to Pay Taxes

Mon, 19 May 2025 00:31:46 GMT

As much as 85% of your social security income can become taxable.

Is this actually a myth?

Truth to tell, I haven’t had anyone who is actually retired tell me this. They know the truth, which is that this myth is patently false. I have, however, had many younger people share their belief that social security and other retirement incomes aren’t taxable, a painful lesson to learn by being wrong.

How much of retirement income is taxed?

As much as 85% of your social security income can become taxable. The math of how to determine the specific amount is complicated, but essentially if you have other income streams you will likely see some portion of your social security income taxed.

The added sting comes from these earnings beings taxed a second time. Your social security contributions throughout your life came from after-tax funds either held from paychecks or paid in the form of self-employment tax. This means I paid taxes on the money paid into social security at the time I paid in, and then get stuck paying taxes on the money a second time when I receive the benefits.

Wow! That's kind of redundant. What about 401K/IRA contributions?

Most pension income will be taxed and unless your 401K/IRA contributions were all ROTH contributions, then there will be some taxes due on your distributions.

So, tax planning is important?

Tax planning for retirees with multiple income streams can be very complicated. When each person should start drawing their social security depends on a variety of factors as well as the personal philosophies of the taxpayers. There most certainly will be income taxes paid in most situations.

We always recommend working closely with your financial and tax advisor to setup the most favorable outcomes for your finances leading up to and during your retirement years. This is best accomplished with in-person planning, but if you prefer to research for yourself the following link may be helpful:

https://www.thebalance.com/tax-planning-strategies-for-retirees-3193492

Myth Buster with Josh: Deducting a Business Loss Against My Other Income (s)

Mon, 19 May 2025 00:31:46 GMT

If you invest $50k into a business venture that fails, your losses will be limited to the $50k invested.

This is a question I often get from higher income earners looking to minimize their tax liabilities. It’s understandable to want to keep more of our hard-earned money from the sticky fingers of the IRS, but having business losses may not always have the impact you are hoping for.

This topic can get very deep, so we are going to stay very surface level here. Not all business income is the same - The IRS considers some income as passive, other income as active. Each has its own set of guidance, regulations, and rules on how to apply the various income streams.

I cannot deduct passive loss against active income. So, a taxpayer throwing money at a business investment in which they will have zero involvement regarding their time is impossible to offset business gains from their primary business where they do devote all of their time.

In general, the IRS has thought through most ways we could easily game the system as taxpayers. It really doesn’t make sense to be able to deduct losses for more skin than one has in the game, so there is a whole section of Internal Revenue Code devoted to policing this. Originally adopted in 1976, Sec 465 addresses the At-Risk Limitations for deducting business losses.

If you invest $50k into a business venture that fails, your losses will be limited to the $50k invested. As such, the belief that one can invest in a business with the goal of continuing to lose money in excess of their investment and experience tax benefits is false.

Losses in excess of investment are not lost forever though. They can be carried forward to a time when the business does have income to offset it. I do see this commonly early on in startups. Some of the capital they have used is borrowed and as such their losses have exceeded their initial investment from owner(s). Those losses cannot be deducted during that tax year, but yield future benefits by offsetting income once the entities became profitable.

Bottom line, the IRS’s view of businesses is that they are held for profit and not a hobby. If a business goes long enough without showing profits, there can be complications with the IRS which cause you to lose all business deductions. For more information on At-Risk Loss Limitations, the link below may be helpful.

http://loopholelewy.com/loopholelewy/01-tax-basics-for-startups/passive-activity-rules-00-historical-note.htm