Individual Tax

Employment Matters: The Difference Between Contractors and Employees

When there’s extra work that needs to get done and there are no sufficient employees to do the job, companies usually hire more workers to keep up with the customer rush. If you happen to find a job in a company, make it a point that you understand your status in that company. That way, you will know how you are supposed to be treated by your new employer.

More often than not, problems arise because independent contractors think of themselves as employees, and vice-versa. For some, knowing whether they are contractors or employees doesn’t matter because all that matters to them is that they got a job and an income. However, they don’t realize that not knowing which classification they belong to—independent contractor or employee—will put them at the risk of tax troubles in the future.

But how does the law classify contractors vs. employees?

Telling Between Contractors and Employees

On the surface, you probably cannot tell what sets contractors apart from employees because most of the time, they do the same work. However, the law views them differently. The law also views the companies that hire them just as differently.

Basically, the thing that makes contractors different from employees is their degree of independence and control over the work that’s assigned to them. Usually, while an employee performs tasks that are dictated by others and are provided trainings to effectively do the job, an independent contractor has more than one client and sets his own hours at work. A contractor typically does not have a boss and he uses his own tools in performing his job. Also, his salary doesn’t automatically come at a definite date because he invoices for each of his completed assignments.

While that seems pretty much understandable, there can sometimes be gray areas, too.

In many cases, companies prefer hiring contractors instead of employees so they can save on labor costs. Financial-wise, hiring contractors makes more sense because contractors are not entitled to benefits. Also, companies save considerably on taxes since in hiring contractors, it no longer becomes necessary for the employer to pay portion of the state unemployment taxes.

Companies that follow the law and take the employee route usually regret their decisions at some point in the future because of the cost that making someone an employee entails. That explains why small businesses that operate on tighter margins are often tempted to hire contractors instead of employees, even when the job that needs to get done calls for an employee.

To minimize their costs, business owners make people believe that it is more advantageous to be a contractor than an employee since contractors’ take-home pays are bigger. While that may be true on the surface, that is not as simple as it seems.

The Tax Implications of Contractual Work 

If you are an employee, your employer is the one that pays half of your Social Security and Medicare taxes and withholds half of these taxes from your salary. That and the withholding of your federal and state income taxes are the reasons why those employees who work at $9 per hour at fast-food restaurants take home less every payday.

So, does that prove that being a contractor is better than being an employee?

The answer is not necessarily. Why? Because independent contractors pay 100% of all their Social Security and Medicare taxes when they file their tax returns, and pay all the income taxes that were not withheld. And if you are a contractor and you failed to make estimated tax payments every quarter to cover your taxes, prepare yourself for an unfortunate surprise come April. This only goes to show how tax responsibilities affect the amount that employees take home during payday versus the amount taken home by contractors.

Contractors Escaping Taxes

 Sounds common, doesn’t it? Many contractors believe that one of the advantages of being an independent contractor is that they get to escape taxes. Actually, they don’t. Well, that’s always possible. But that is not legal.

If you are a contractor and are paid in cash, don’t think that that already lets you get out of paying taxes and not report it. Whether your pay comes in the form of a check, cash, digital transfer or barter, and regardless of its amount, remember that every pay you get for each work that you do is taxable income.

Many contractors get all the more confused about taxable contract income because of the amounts that the IRS uses to require reporting of earnings. Remember that when you are a contractor, you get Form 1099-MISC to lay down the details of how much you have made for each job. Form 1099-MISC is what you need, not a W-2. However, as a contractor, an employer does not need to send you a form 1099 if your earnings during the tax year in question is less than $600.

The law can’t stress enough that the abovementioned rule is just a reporting requirement and has nothing to do with your taxable income. However much you earn, your earnings are always legally taxable and should be reported either on Schedule C or as other income on Form 1040.

For your FICA taxes, which refer to your Social Security and Medicare taxes, these taxes are self-employment taxes which you are responsible for in full. If you are an independent contractor, you should report the amount of your FICA taxes and pay them via Schedule SE.

While being an independent contractor has its share of advantages when it comes to taxes, there are instances when a business hires a contractor who is eventually deemed as an employee. In such cases, both parties lose significant amount of taxes, interests, penalties and premiums.

Since the relationship between a company and a worker sometimes tends to be a gray area, it is imperative that you protect your status as an independent contractor. Well, that is if you are really an independent contractor. To make sure that your work as a contractor remains independent of your employer, it should be able to pass the Four Point Test.

Determining Your Status

 If one asks you now whether you are a contractor or an employee and what makes you think so, do you know how to answer?

In Canada, a four-point test helps workers to determine their relationship with the business that you are working for. The agency clearly sets out a method that lets tax payers and workers identify the nature of their relationship with their companies.

The four-point test makes clear-cut distinctions between contractors and employees based on their control, tool ownership, risk of loss and integration.

  • Here, the issue is who controls the worker. If the employer has all the right to hire or fire you, determine your salary, decide on the time and place of your work as well as the manner in which you should perform your work, then you are an employee. Even if the employer does not directly control how you do your job, if he still has the right to do so, then an employer-employee relationship exists between the two of you.

 On the other hand, if you are a contractor, it is not necessarily the employer that runs the ship. As a contractor, you decide how you are going to perform your job and you maintain your right to decide where and when you are going to get the work done. In short, you are the only person responsible for planning the job that you need to get done.

  • Ownership of Tools. When it comes to tool ownership, the common notion is that what sets contractors apart from employees is that contractors supply their own tools. While that may be true, the problem is that it is also customary for other employees to provide tools for themselves so they can perform their jobs, such as in the case of garage mechanics and painters.

If that is the case, then how does tool ownership differentiate a contractor from an employee? According to CRA, the cost of using the tools is a better indication of whether you are a contractor or an employee. As per the CRA rule, you are considered an independent contractor if you purchase or rent large tools that call for major investment and expensive maintenance. Otherwise, you are an employee. Another good example of a self-employed, independent contractor is a home-based IT worker who uses his own computer to perform his job.

  • Chance of Profit/Risk of Loss. Here, determining which type of relationship exists between the business and the worker heavily depends on the financial involvement of the latter. Take a look at these questions:
  •  Do you have a chance of gaining profit?
  • Are you at risk of incurring losses due to damage to materials, delays or bad debts?
  • Do you cover the operating costs?

If your answer to all of these three questions is a Yes, then you are considered an independent contractor.

  • This criterion seems to be an attempt to presume the intention of the involved parties. According to CRA, a business relationship exists if the worker integrates the payer’s activities to his own commercial activities. On the other hand, an employer-employee relationship exists if the worker integrates his activities to the commercial activities of the payer.

The CRA does not lay out how to determine such integrations. However, an obvious way of proving that you integrate your own commercial activities is by having multiple clients. If you have only one client, it becomes easy for others to presume that you share an employer-employee relationship with that client. But be careful when having a single client, because that puts you at risk of being declared as a personal services corporation by the CRA.

Deciding Whether to Become an Employee or a Contractor

 Based on the facts discussed, it looks like being a contractor can be beneficial for you in terms of earnings and taxes, so long as you are prepared. However, remember that being an employee or a contractor is not really one of those decisions that you make when you look for a job. In reality, it is the business or company that decides whether you are a contractor or an employee.

Most of the time, employees are carried on the books, unlike contractors. So as a contractor, it is your responsibility to enshrine your relationship with the company you are working for through a contract. This contract should focus on the first three points of the four-point test and set out the intentions of both parties. Since you are an independent contractor, you have to make sure that such a written agreement is carefully crafted so your status is protected in case the other party subsequently changes his mind and argues that your relationship is not what you think it is.

At the end of the day, it is the business’ responsibility to weigh certain factors to determine whether a worker is an independent contractor or an employee. While other factors may indicate that one is an employee, other factors may indicate that he is an independent contractor. Apparently, there is no magic that stands alone in determining one’s status, but the key to making the right determination is by looking at the entire relationship that the person has with the company he is working for.

In a nutshell, what makes a worker an independent contractor is his being his own boss, although his work should still stay within the definitions of a contract with the party he is working for. Also, he is not eligible for benefits provided by the employer and retains a certain degree of independence and control. On the other hand, a worker is an employee if he treats the business as his stable source of income, is eligible to benefits and pensions, and gives up elements of control to his employer. He should also be working within the time and place specified by the employer.

Thinking About Becoming An Enrolled Agent ?

 Do you want to be called a tax expert? Is it your goal to represent taxpayers before the IRS? Do you desire to be respected as a professional?  If so, you should work towards becoming an enrolled agent or EA.

Enrolled agents are specialists who represent the cream of the crop when it comes to taxation. They are the only federally recognized tax practitioners who can represent taxpayers before the Internal Revenue Service.

EAs and CPAs can help taxpayers facing the various tax problems:

  • Tax evasion
  • Tax fraud
  • Tax debt
  • Failure to file/pay tax penalties
  • IRS audit
  • Tax liens
  • Tax levies
  • Unfiled tax returns
  • Appeals
  • Collection issues

There are only less than 50,000 practicing EAs in the United States, according to the National Association of Enrolled Agents (NAEA).

The relatively small number of practicing enrolled agents in the US can be attributed to the expertise necessary to become one, as well as the stringent requirements for maintaining the license.

While it isn’t easy to become an enrolled agent, the rewards are more than worth it, so to speak.  Enrolled agents are highly in demand. They are needed by law and accounting firms.  These professionals can also find employment in banks and investment firms. Some pros also choose to put up their own private practice.

How to Become an Enrolled Agent

 Unlike other professional designations, there is no educational requirement for a person wanting to become an enrolled agent.

However, you must prove your knowledge on tax related matters by either passing the EA exam or working with the IRS for at least five years.

The EA exam is also called the Special Enrollment exam. It consists of three parts, with each one testing your knowledge on taxation.

The first part concerns individual taxpayers, covering sections on income and assets, deduction and credits, taxpayer information, taxation and advice, and returns for individuals.

The second part focuses on business entities with sections on businesses, specialized returns and tax payers, and business financial information. It is widely considered by EAs as the toughest section in the exam.

The third part focuses on representation, practice, and procedure.

Aside from passing the test, you will be subjected to a thorough investigation conducted by the IRS.

Maintaining Certification 

If you successfully passed the exam, you will be federally recognized as an enrolled agent. However, you will need to do the following to maintain your certification:

  1. Renew your Preparer Tax Identification Number (PTIN) annually.
  2. Renew your status as an EA every three years
  3. Undergo 72 hours of continuing education (CE) every three years. There’s a minimum requirement of 16 hours of CE per year, with at least two hours on ethics.  The need to undergo at least two hours of ethics training annually is in line with the Department of Treasury’s Circular 230.

 Joining Professional Organizations

 There are numerous professional organizations of enrolled agents. The NAEA is perhaps the biggest and most prestigious of them.

The Washington, DC-based organization aims to promote the highest level of professionalism, skills, and knowledge among its members. It is also a staunch advocate of taxpayer rights.

Established in 1972 as an offshoot of the Chicago-based National Association of Enrolled Federal Tax Accountants, the NAEA has grown into a large organization with more than 11,000 members.

Those members are demanded to take 30 hours of CE every calendar year, or 14 hours more than the 16 hours set by the IRS. They are then required to report the number of hours of CE they’ve garnered in the past year for renewal of their membership in the upcoming year.

The NAEA lets its members earn missing CE hours in the next calendar year to make up for the less than 30 hours that they accumulated in the previous year.

NAEA Membership Benefits

 While there are other professional groups of enrolled agents, the NAEA is widely considered to be the most prestigious in the country. Aside from completing annual continuing education that surpasses the requirements of the IRS, NAEA members are known to abide by a code of ethics. They also conduct themselves in a very professional manner.

Once you become an enrolled agent, you should aim to join the NAEA. Becoming a member of this organization opens the door to numerous professional benefits such as:

  1. Continuing education. Members of NAEA can participate in seminars, conferences, and conventions that can update their skills and knowledge, and set them up for success. Some of the more common CE topics include ethics, tax preparation, accounting, advanced IRS summons, among others.
  1. Participation in year-long events. NAEA conducts seminars, conventions, and meetings during the entire year. These events provide networking and educational opportunities to its members.

A key event in the NAEA calendar is the NAEA national conference. This is the only annual educational event in the country designed particularly for Circular 230 practitioners looking to focus on client representation before the IRS. The event is anchored by the National Tax Practice Institute.

  1. Enhanced reputation. NAEA works to spread the word about the benefits of hiring an enrolled agent. It taps both traditional media such as print and broadcast and social media to effectively increase the public’s knowledge about enrolled agents, and thereby enhance the potential value of EA to taxpayers. Simply put, the organization strives to make the taxpaying public more appreciative of the value of enrolled agents.
  1. Information sharing. The NAEA offers a tax knowledge base where members can look for answers to some of the more frequently asked questions of tax practitioners.
  1. Marketing tools and membership discounts. The organization offers discounts for office supplies and software that their members can use in their respective offices.

Participating in NAEA Courses

 The NAEA as well as its state affiliates are known to host numerous continuing education (CE) courses. These courses are held all year-round and provide an opportunity for current EAs to hone their skills and keep themselves updated on the latest taxation issues.

Should you become an EA and eventually a member of the NAEA, you can browse the organization’s website, www.naea.org to find and apply for an organization-sanctioned course.

The website features the “Continuing Education” section where you and other EAs associated with the group can learn more about the requirements for continuing education credits.

There’s also the “Calendar” section in the website where NAEA events for the entire year are posted.  The events range from quarterly meetings, annual conventions, and seminars. Attending these events not only provide enrolled agents with the opportunity to earn CE credits, but also get some relaxation in a world-class resort.

For 2017, some of the cities where NAEA courses are scheduled to be held are Orlando, Las Vegas, Denver, and Reno.

Enrolled agents, thus, can improve their skills and knowledge, maintain their certification, and renew their NAEA membership while getting treated to a few days of leisure and vacation.

From a professional standpoint, NAEA courses also provide enrolled agents with the opportunity to network with some of the most dedicated tax professionals and learn from accomplished  tax authorities in the country.

NAEA and its state affiliates, in fact, offer its courses even to non-members.  There are seminars which are open to enrolled agents who are not members of the NAEA and its state affiliates. Signing up for a NAEA course may also benefits like complimentary membership, special member discounts, and access to special publications.

It is also possible to get discounts if a group of enrolled agents participates in a NAEA course. The NAEA and its state affiliates usually give discounts to groups of three or more colleagues who are joining a seminar, convention, or conference.

Enrolled agents can also attend one or two days of multiple-day seminars. The NAEA offers one-day only rates for most of its courses, meaning that EAs don’t have to attend the entire course.

The easiest way to register to any NAEA course is through the Internet. The NAEA website, as well as those of NAEA’s state affiliates, usually have downloadable PDF registration forms which enrolled agents can fill out to signify their participation in a particular course.

How to Save in NAEA Courses Participation

 Truth to be told, participation fees in NAEA courses and events aren’t cheap. The cost of participating in a continuing education course can run to hundreds of dollars. The cost may also be affected by other factors such as the location as well as the number of days of the event.

Yet enrolled agents can deduct the costs of their participation in NAEA courses in their next tax returns. After all, these are considered travel expenses which are defined by the IRS as common and accepted in a trade or business.

Enrolled agents can claim most of the expenses they incur while attending a NAEA organized event or conference. They can write off registration costs, lodging expenses, 50 percent of their meals, and incidental expenses.

Communication-related expenses during a NAEA convention, such as business calls and fax machine fees, may also be written off by enrolled agents. The same goes for other ordinary and necessary expenses related to the business travel like dry cleaning and laundry as well as tips paid for any expenses during the convention.

Transportation expenses can also be written off by enrolled agents who participate in a NAEA course. These include airfare, bus fare, or taxi fare between the enrolled agent’s home and the location of the event.

Since most NAEA events are held in the United States, enrolled agents should have no problems claiming the expenses they incurred in participating in a NAEA continuing education course. However, it is worth mentioning that even conventions held outside the United States may be deducted as a legitimate travel expense.

These include countries such as Aruba, Bermuda, Bahamas, Dominica, Dominican Republic, Costa Rica, Republic of Palau, Panama, Trinidad & Tobago, Jamaica, and Honduras, among others.

Of course, enrolled agents know very well that there are also other factors to be considered in justifying the location of a convention. These include, among others, the residence of the participants, purpose and activities of the convention, and locations of previous events.

Claiming travel expenses in the next tax return isn’t the only way for enrolled agents to save the next time they participate in a NAEA course. They can also seek the assistance of professional EA groups. There are numerous organizations of EAs – and not just the NAEA– that offer scholarship programs to  both current and aspiring enrolled agents.

For example, the California Society of Enrolled Agents offers scholarship to California residents wishing to pursue accounting, finance, and other courses in preparation for the special enrollment preparation.

It also offers scholarship to current EAs in California who wish to take up courses like Tax Court in their desire to broaden their knowledge in the field of taxation.

The NAEA, meanwhile, has its own scholarship program funded by its members. This grant covers the registration expenses of educational programs offered at NAEA conferences.

Joining Online Courses

Enrolled agents may also join online courses or webinars offered by the NAEA.  Online courses are a lot cheaper than seminars, conventions, and other continuing education classes offered by the organization.

Moreover, these courses are suited for enrolled agents who don’t have the time to attend seminars or meetings organized by the NAEA. Participants of online courses can also earn continuing education credits.

There is also a lot of variety in the topics discussed in online courses. Some may be aimed at enhancing the knowledge and skills of enrolled agents such as seminars on tax update, while others may be focused on enabling EAs to improve their practice such as using social media to reach out to more potential customers.

There are a lot of career opportunities awaiting enrolled agents in the United States. Organizations particularly the NAEA are more than willing to help professional growth of EAs. One way to  achieve this is the offering of various NAEA courses such as seminars, conventions, and meetings.  Enrolled agents should be pragmatic enough to grab the opportunity and participate in NAEA courses, whether held in or outside the US.

Ten Recordkeeping Rules and Five Bonus Tips in Claiming Travel Expense

Good recordkeeping may not be in the list of business secrets of successful entrepreneurs. But for the company’s accountant or bookkeeper, it is very important.  It can significantly reduce the amount of profit that a business will pay tax on. Keeping accurate and organized records make it easier for companies to track their cash flow, save time and trouble in filing their tax returns, and perhaps more important, ensure that they are tax-efficient.

Good recordkeeping is particularly vital for business owners and contractors who go on a business trip.  The Internal Revenue Service (IRS) allows business owners to claim tax deductions for travel-related expenses such as:

  • Lodging
  • 50 percent of the costs of meals
  • Baggage charges
  • Air, rail, and bus fare
  • Cleaning and laundry
  • Taxi fare and car rental
  • Computer rental
  • Public stenographer fees
  • Telephone or fax expenses
  • Tips on qualified expenses

If you are a business owner,  you should understand how good record keeping is vital. Keeping accurate records will back up your tax deduction claims. And it can spell the difference between winning an audit and the IRS possibly digging up your other tax returns.

The following are some of the recordkeeping rules you should keep in mind when you are to claim on a business trip:

  1. You can’t claim tax exemptions for estimated or approximated expenses.

The IRS doesn’t allow businesses to deduct amounts based on approximate or estimate. You cannot guess the amount you spent for your gas or toll fees,  neither for the cost of your meals during the business trip.

It is thus recommended for entrepreneurs or their bookkeepers to keep adequate records proving their business trip -related expenses.

You should be accurate on the amount to be written off. The IRS recommends keeping documentary evidence to prove your expenses, such as receipts, bills, and checks.

 However, documentary evidence isn’t required when the travel related expense is lower than $75.  You don’t also have to present receipt for meals and lodging expenses if you are to claim per diem, or you took public transportation for which a receipt isn’t readily available.

 You should keep timely records.

 The IRS also recommends keeping records of a business travel during or near the time of the trip. It should also be supported with sufficient documentary evidence. This can make the record more believable than a statement prepared at a later date.

 Let’s cite an example. A business owner wrote off more than $20,000 in his tax return, citing that the amount represented the gas expenses he had when he went out of town during several occasions in 2013 to meet several prospective clients.

 Two years after the trip, the IRS decided that it had enough grounds to audit his tax returns. In order to substantiate his claim, he presented a 2013 calendar as well as printouts of driving directions generated by an online web mapping service. The directions also specified the distance supposedly traveled by the business owner from his place to the offices of his clients.

 Despite those documents presented , the IRS will still disallow the claims of the business owner.  For one, the documents presented were prepared two years after the business trip. Therefore, there is a lack of truthful recall on the part of the entrepreneur to justify the said claim even though an online mapping service was used.

 This illustrates the importance of keeping timely records of your business trip. While you don’t have to record information as soon as you get home, you don’t have to wait for months to do so, either.

  1. You must state the business purpose of an expense.

The IRS encourages business owners and employees who are claiming a business travel exemption to provide a written statement indicating the purpose of an expense. You can indicate that a conference you attended is for networking and meeting potential clients.  You can back up your claim by showing the conference program or invitation from the organizer.

However, this may not be needed if the purpose of an expense is obvious given the surrounding circumstances.

The easiest example of this would be a sales representative. Given the job description of the worker, it is understood that he or she is constantly travelling.  Thus there is no need to submit a written statement detailing the business purpose of each and every trip. The sales representative would only have to record the date of each trip, total miles covered, and back up his or her claims with documentary evidence like receipt or record of delivery.

You can also withhold confidential information in stating the purpose of a business travel expense.  You don’t have to be explicit in stating the purpose of a business meeting like mentioning the amount of deals you booked over dinner.

  1. You can’t use credit card statements to claim an expense.

One of the more common mistakes that business owners make when writing off a business trip expense is using their credit card statements. The IRS, though, won’t accept this as documentary evidence.

A credit card statement can be likened to a canceled check. It only shows the costs but not any further evidence to prove that the expenses were for a legitimate and necessary business purpose.

You should present a receipt alongside the credit card statement to substantiate the travel expenditure.

  1. You should provide direct and supporting evidence in case you have incomplete records of an expense.

If you cannot provide complete records to support a tax deduction, you can still write off an expense by furnishing direct evidence in the form of a written or oral statement and supporting evidence. The written or oral statement details the cost, time, place, and date of a business trip expense like meals or transportation. It may be a written statement from you, your associates, and guests. Documentary evidence, on the other hand, may be receipts or paid bills.

In the absence of documentary evidence, you can present adequate evidence to prove the character of the expense. In the case of lodging expense, a hotel receipt can be presented to and admitted by the IRS if it provides essential information such as the name and location of the hotel, the dates of the stay, and separate amounts for lodging, meals, and communication expenses.

 Another example of adequate evidence would be a restaurant receipt. It can be presented to the IRS for meal expenses as long as it indicates the name and location of the restaurant, the number of people who were served, and the date and amount of the expense.

6. You should record expenses separately.

The IRS says that each payment is considered a separate expense.

Let’s say that you took a taxi to go to a restaurant where you met a client. The dinner expense and the taxi fare are two separate expenses. You should, thus, record them separately in your records.

It is also common for businessmen to treat their clients to sports events. If you bought season or series tickets, and then used these for business purposes, then each ticket in the series should be treated as a separate item.

You can divide the total cost of the season tickets by the number of games in the series to get the cost of each ticket.

 7. You can combine items if the expenses are of a similar nature.

You can combine expenses of a similar nature, and record them as a single expense. These expenses should have happened during the course of a single event.

For instance, you don’t have to record each and every drink during a cocktail party as separate expenses. You can record the total expenses for the refreshments as a single expense.

 8. You can record all vehicle/transport expenses and then divide them into business and personal expenses at the end of the fiscal year.

You can claim gas expenses if you used your car during a business trip. It is also possible to record all your expenses during the year, and then divide them into business trip and personal expenses at the end of the year.  However, you should keep an accurate mileage log if you are to claim a tax deduction for your business trip related expenses.

The mileage log should indicate the starting mileage on the odometer at the beginning of the year, as well as its ending mileage at the end of the year. Every time you use your vehicle for a business trip, you should record details such as the date of your travel, your starting point, and destination. You must also write the purpose of your trip, the starting and ending mileage of the vehicle, and other trip-related expenses such as tolls and parking fees. It is important to keep your mileage log updated regularly, so that your records will be precise.

 9. You can claim deductions using your actual expenses, or by using the standard mileage rate.

There are two ways of claiming transportation related expenses during a business trip. You can deduct your actual expenses, or use the standard mileage rate set by the IRS.

The latter is easier to follow, which makes it the more popular option among employees and entrepreneurs. For 2017, the mileage rage is 53.5 cents for every mile. You simply have to multiply the miles that your vehicle has accumulated for business-related expenses.

For example, your car drove 20,000 miles for business trips in 2017. You will then multiple 20,000 by 53.5, giving you a total of $10,700. This is the amount that you can write off in your next tax return.

You may opt to deduct your actual expenses instead of using the standard mileage set by the IRS. However, you should have a thorough record of your gas, parking, and toll expenses. You can also deduct other expenses like repair and maintenance, tires, car washing, car repair, and gas and oil replacement. While this method requires a lot of record keeping, it can save you a lot of money because it usually results in a larger tax deduction.

  1. Keep records and receipts as long as you can.

You may wonder how long should you keep those receipts related to a business trip that you had two years ago. The IRS recommends keeping records as long as you can, as there will always be a possibility that your tax return is audited up to three years from the date that you filed it.

Bonus Tips

While entrepreneurs are entitled to many tax deductions when they go on a business trip, they won’t be able to write off expenses if these are not properly recorded. The last thing you want to have is the IRS auditing your tax returns for making unsubstantiated claims. Here are some tips to keep in mind so that you will have an easier time in recording your expenses while on a business trip:

  1. Scribble down notes on receipts. This is particularly helpful if you are to claim meal expenses. You should list down the names of those who you dined with, and the business purpose of the meeting.
  1. Scan receipts. If you’re the type of person who keeps on losing receipts, you can simply scan or take photos of these essential documentary evidences.
  1. Keep track of your expenses in a daily business journal. You can download a good daily business journal that you can use to record all your expenses during a business trip.
  1. Use debit and credit cards as much as possible. Using cash can be disadvantageous for anyone on a business trip. It is easy to spend but hard to keep track of.  Instead of using cash, simply your debit and credit cards, then reconcile them with your receipts.
  1. Use an app. There are many apps that you can use to track your business travel expenses. These apps can make it a lot easier for you to document your expenses and make an accurate tax claim.

How to Get Reimbursed for Tips and Other Incidental Expenses During a Business Trip

Traveling for business has a lot of perks. It may mean spending some time away from the office and dealing with a lot of tasks as a result, but for the most part,  it can be very rewarding.

You do not have to be a boss to understand how rewarding business trips can be. Business owners and executives, for one, can meet prospective clients and suppliers.  They can seal deals by wining and dining their associates. Or they can strengthen their relationships with current partners.

Employees, meanwhile, can improve on their skills, update their knowledge, and network with peers when they attend conventions and business conferences. Plus, the time away from the office can re-energize them and make them more productive and inspired when they return to their respective work stations.

Claiming tax deductions

What’s more encouraging is that most business-related expenses can be claimed as tax deductible. Anything related to the business trip can be written off, from airfare, taxi fare, lodging, communication charges, and supplies.

Even incidental expenses can be claimed as tax deductible. These are small costs incurred during a business travel. It may cover for tips or fees that an employee or business owner gives to porters, baggage carrier, maids, and stewards.

In short, incidental expenses are gratuities given to staff of restaurants, hotels, cruise ships, and similar establishments.

Tipping Standards

Tipping is a customary practice in the United States. It should be noted that the federal minimum wage of $8 an hour, so tips can help make up for the low pay of servers.

Thus, business travelers will normally have to spend for gratuities extended to waiters, bell boys, porters, and other servers that they will encounter during their trip.

While there’s no standard rate as far as tips in the US are concerned, the following is a guide on how much business travelers tip for people who serve them:

  • Taxi/limousine driver—at least 15 percent of the total fare
  • Porter- $1 per bag
  • Valet parking attendant– $1-2 for every car retrieved
  • Restaurant waiter/waitress- at least 15 percent of the total bill less tax
  • Bell staff- $1 for every bag delivered to a room
  • Buffet service– $1 to $2
  • Bartender/cocktail—at least 10 percent of the total bill

Tipping, however, is not practiced in other countries.  In fact, outside the United States, the practice is not customary.

For instance, tipping in Australia is practically non-existent. This can be attributed to the fact that the minimum wage in Australia is $16 per hour, or around $622 a week.

It’s also not a practice in other countries such as Japan, Argentina, and Estonia. In most countries in Europe, such as France, United Kingdom, the Netherlands and Finland, tips are already included in the bill.

What’s Not Included in Incidental Expenses?

The IRS, however, does not consider the following as incidental expenses:

  • Costs incurred in cleaning and pressing of clothes
  • Long distance telephone calls
  • Local calls
  • Internet connection
  • Fax services
  • Gas for rental vehicles
  • Parking fees

These costs incurred, after all, are reimbursable as other expenses.  For example, costs of cleaning and ironing of clothes can be written off as cleaning expenses. Local and long distance calls, as well as fax and Internet services, may be claimed as communication expenses. Gas for rental vehicles and parking fees, meanwhile, are considered as transportation expenses.

Incidental Expenses-Only

Because incidental expenses are small, it is very common for business owners and employees usually pay out in cash.  The minimal amounts involved in a tip, and the fact that there’s no need to issue a receipt for such expense, has prompted the IRS to set a rule when it comes to claiming incidental expenses during a business trip.

According to the IRS, a business owner or employee who was on a business travel can opt for the incidental-expenses only method in claiming a deduction. In this method, the taxpayer can write off incidental expense of $5 a day.

This method spares taxpayers from the hassle of keeping tabs of the costs they incurred for the tips given during the course of a business trip. Since tips are very small, it can be difficult for business travelers to keep track of the expenses they have incurred.

This method, however, can only be used when the taxpayer did not incur any meal expense.

Thus, a taxpayer cannot claim incidental expenses if he or she had and claimed meal expenses during the business travel.

Let’s cite an example.  Victoria was sent by his boss to a three day business trip to New York.  She incurred meal expenses during that trip.  She could have claimed half of the total amount of those meals under tax rules, but because she could not present the actual costs of the meals,  she just opted to claim a standard meal allowance.

Standard Meal Allowance

For 2016, the federal standard meal allowance is $51 a day.

Thus, Victoria can write off $153 for her meals during that trip. However, because she had claimed meal expenses as tax deductions, then she won’t be allowed to deduct $15 as incidental expenses.

If Victoria didn’t claim any meal expenses, then she can write off the $15 incidental expenses that she incurred during the trip.

By using the standard meal allowance, Victoria has practically claimed both meal and incidental expenses.

Victoria can receive this allowance if her employer does any of the following:

  1. Provides her with lodging, or furnishes it in kind.
  2. Reimburses her for the actual cost of lodging basing on the receipts presented
  3. Pays for the lodging
  4. Expresses reservations about Victoria incurring lodging expenses. This may be due to her having friends or relatives in New York, where she can stay with.
  5. Devise an allowance based on a formula similar to computing Victoria’s compensation like number of hours worked or number of miles traveled.

As mentioned earlier, the M&IE allowance of $51 applies to most small localities in the United States. However, a higher allowance applies to bigger cities like San Francisco, and yes, New York. As of 2017, the M&IE allowance for New York is $74.

There’s also a special standard meal allowance for those working in the transportation industry.  The IRS defines workers in the transportation industry as those who are directly involved in moving goods and people by various modes of transportation such as airplane, bus, barge, ship, or train.

Workers who are regularly required to travel away from their residence, and have to travel to different areas that are qualified for standard meal allowance rates, are also considered to be transportation workers by the IRS.

Those who are in the transportation industry get a standard meal allowance of $64 a day.

Claiming Per Diem

There are instances, though, when claiming the standard meal allowance or using the incidental expenses only method won’t suffice to cover the expenses incurred by a business owner or employee.

For example, what if Victoria had to shell out more than $30 in tips alone during her three-day trip?  She might have brought a lot of bags so that meant she had to give tips to the bellboy and porter. She could have even given the taxi driver a tip for helping her carry her baggage.

One way that Victoria can reimburse those expenses is to claim per diem or per day. Per diem is a daily allowance for expenses that companies give to employees on a daily basis to cover expenses when on a business travel.

Per diem rates cover the costs of lodging, meals, and incidental expenses incurred by an employee during a business trip. If Victoria opts to use this method instead of the incidental expenses only method and the meal and incidental expenses allowance, then she can get reimbursed not just for the tips that she gave but also for her meals and lodging expenses.

Claiming per diem also has one distinct advantage—it spares employees from preparing documentation required to support business travel expenses.  If Victoria opts for this method, then she no longer has to collect every receipt she gets during the trip. There’s also no need for her to note the time, place and purpose of each business meeting she attends. Moreover, she no longer has to hold on to those receipts and other documentation for two to three years, just in case the IRS calls in and questions her business travel deductions.

It can also mean faster reimbursement of expenses on the part of the employee, as there is no need to review and approve monthly expenses reports. It can also prevent processing delays caused by incomplete documentation, or when a supervisor inquires on the reasonableness of a claim.

Simply put, claiming per diem rate simplifies life for employees like Victoria.

However per diem rates aren’t paid to individuals who own more than 10 percent of the business. Thus, business owners cannot opt for this method in claiming tax deductions.

The IRS uses the high-low method in determining the per diem in certain areas in the United States.  Simply put, employees who work in areas like San Francisco, Boston, and Washinton D.C. have a higher per diem rate than those working in areas in the ‘low cost’ list.

For the fiscal year 2017, the IRS has set the per diem rate for high costs areas at $282. The breakdown is $214 for lodging, and $68 for meals and incidental expenses. This applies to all high cost areas within the continental United States.

Some of the high cost areas for 2017 are Los Angeles, San Francisco, Santa Monica, Santa Barbara, and San Jose in California; Denver and Aspen in Colorado, and Sedona in Arizona.

Chicago, Maine, Maryland, and Seaside in Oregon are other high cost areas as defined by the IRS. In Florida, cities like Miami and Fort Lauderdale are classified as high cost areas.

Other areas where the per diem rate is $282 for 2017 are Hershey and Philadalphia in Pennsylvania, Park City in Utah, Seattle in Washington, Jamestown, Middletown, and Newport in Rhode Island, and Virginia Beach and Wallops Island in Virginia.

For all other areas, the per diem rate is $189 with lodging at $132 and meals and incidental expenses at $57.

Compared to the previous year, the rates have gone up by $7 for high cost areas and $4 for the low cost areas.

Employers should take note that lodging and meal and incidental expenses are separated from each other. Thus under certain circumstances, they can only reimburse for the meals and incidental expenses of their employers. For instance, if Victoria’s company paid for her hotel or lodging then she is only entitled to a per diem reimbursement of her meals and incidental expenses.

In such case, she can only receive a reimbursement of $68 for M&EI as the lodging costs have been shouldered by her employer.

Exclusions

It should be noted that transportation costs and mailing costs aren’t included in incidental expenses. These include transportation between places of business and lodging, as well as mailing expenses incurred for filing travel vouchers.

The IRS states that the high-low method must be used by companies in reimbursing their employees’ travel expenses within the continental United States for the fiscal year. However, it is up to them to use permissible method when it comes to reimbursing their employee expenses for business travel outside of the United States.

Employers are also required to continue using this method for an employee in the last three months of the fiscal year.  This means that the same method utilized in the first nine months of the year should also be used for the final three months.

Conclusion

While tips extended to waiters, bellboys, and other servers are not as costly as meals and transportation expenses, the amount can quickly accumulate during a business trip. Fortunately for most employees, the IRS allows these expenses to be reimbursed either through the incidental expenses-only method, per diem, or the meal and incidental expenses method.

How Freelancers Can Write Off their Business Travel Expenses

While there are many risks of being a freelancer, it cannot be denied that there are plenty of benefits, too.

One advantage of being self-employed is that you can make more money than you would if you were an employee. You can also work at the comforts of your home.

Moreover, freelancers like you also get to enjoy many tax deductions like home office and business travel.

If you haven’t realized, going on a business travel can benefit your trade.

Here are three good ideas that you may want to explore if you want to maximize your tax deductions by going on a business trip anytime soon:

  1. Visiting a client

Perhaps you have a client in an area away from your tax home, or your primary place of work. You might want to visit that client and several customers to strengthen you relationship with them.

You don’t need to spend the entire them talking to them. You can schedule a meeting for a few hours.  Just make sure to keep note of the things you talked about during the meet.

  1. Meeting a Vendor

Do you know a supplier of a vendor that you can meet in Miami or another area that’s far from your home? You might want to meet him to negotiate a new deal, or how you can improve your business relationship together.

  1. Attend a conference

Are there any workshops, seminars, or conventions that you can participate in?  Attending one that’s relevant to your trade may teach you new skills or update your knowledge. The activity may also give you the perfect time to meet prospective clients or vendors.

What expenses can you write off?

 Any of the abovementioned ideas are justifiable enough to be the purpose of your next business travel. What’s more exciting is that you can deduct all your business travel-related expenses on your next tax returns.

Remember this–you can write off your business travel expenses as long as the primary purpose of your trip is ordinary and necessary for your work.

An ordinary expense is defined as common and accepted in the trade or business that you are in. If you are in the IT field, then your participation in an information security summit can be considered an ordinary expense.

On the other hand, the IRS considers travel as a necessary expense if it is appropriate for a taxpayer’s business.

You can write off the following travel expenses:

  1. Meal Expenses

You can also deduct the costs of meals that you had while you were on a business travel. However, there’s only a 50 percent limit on meal expenses.

There are two methods that you can choose from in figuring out your meal expenses.

The first is the actual cost.  This simply means claiming 50 percent of the actual cost of your meals during your business trip. If you are to use this method, you should have receipts or records of your actual expenses.

The second option is to deduct the standard meal allowance (SMA) of $51 a day, which is the rate for most of the small localities in the US. The advantage of this option is that you don’t have to keep every receipt, as you simply subtract the SMA.

However, the SMA is a bit low. Thus you may not be able to enjoy larger deductions on your tax return if you opt for this method.

Keep in mind that you can claim meal expenses even if your dinner or lunch with a prospective client didn’t lead to a deal. So even if you met potential clients, you can deduct the costs of their meals in your next tax return.

But you may also wonder—can you claim the meal expenses during a business meeting? After all, it is a common practice to discuss a deal or get to know a prospective partner while eating.

The answer is yes–you can also claim meal expenses that you incurred while entertaining customers or potential business partners.

In fact, it is not only the meals served to your clients that you can claim as tax deductible.  You can even include taxes and tips, cover charges if you brought your guests to a nightclub. The rent that you paid for a room in which you held a dinner party for your guests can also be deducted as a meal expense.

But the IRS won’t allow claiming deductible on lavish and extravagant meals. There’s no definite dollar amount for a lavish or extravagant meal, so it can really be tricky for most business owners to determine which meals to expense.

Let’s say that you treated a potential client to dinner at a five-star hotel. Would that be considered lavish or extravagant meal? Perhaps, but you can also justify that it is reasonable given the circumstances. Maybe the client that you met is the CEO of a Fortune 500 company, whom you just can’t bring to any ordinary restaurant.

  1. Lodging Expenses

Unlike in meal expenses where you are limited to a 50 percent tax claim, you can deduct 100% of your lodging expenses during a business travel.

You can even stay an extra day in your destination and claim associated stay-over costs. For example, you had your last meeting on a Friday, but you didn’t leave until Saturday afternoon because you wanted to get a reduced fare on that day. You can claim the stay-over costs on Saturday even though you had no business-related activities on that day.

But if you stayed for a couple more days just to enjoy the sights, then you can’t deduct the hotel charges for those extra days.

  1. Transportation Expenses

Whether you traveled by car, bus, train, or airplane, from your home to the business destination, you can write off your transportation expenses during a business trip.

But if you were provided tickets by a client, your cost is zero.

If you were able to fly because of a frequent flyer reward, then you won’t be able to claim the airfare.

You can also claim transportation expenses to and from the airport to your hotel, and the hotel to the offices of your clients or customers.

If you brought your own car, you can write off your gas expenses, toll fees, and parking. You can even charge the expenses you incurred for maintaining your vehicle, like car wash, replacement of tires, or oil change. However, you have to keep your receipts to prove that you indeed had paid for the said services while you were on a business travel.

Aside from the three major expenses, you can also write off the following:

  • Shipping of baggage
  • Dry cleaning and laundry
  • Business calls
  • Tips
  • Other out-of-pocket expenses such as computer rental fees

The rule of thumb is that expenses that are directly related to your business trip can be written off.  For example, you had paid for the shipping of your brochure or documents needed for a seminar or convention. You can deduct the shipping expenses.

But you can’t expense personal charges like gym or fitness fees. You can’t also deduct fees for movies or games.

Things to Remember Before Traveling for Business

 Now that you have learned the expenses that you can claim on your next tax return, you should then know the things that the IRS will look into before it accepts your tax deduction claim.

These include:

  1. Establish the Purpose of Your Travel

One, your travel should be primarily for business. You can prove this by showing that you have at least one business appointment or meeting schedule before you leave home.

This means that you can’t just depart for the Bahamas or Florida with the hopes of meeting a potential client there. Or collecting business cards of people you would present as business associates.

An invitation to a conference, emails, and other correspondences—these are enough to prove to the IRS that you went to a particular destination for a business-related activity.

But what if you don’t have any invitation or email proving that you went to a certain destination for a business activity?  Let’s say you want to spend a vacation in Miami, and also get some potential clients there.

You can mix pleasure with business, so to speak, by placing several advertisements in the area.

For example, you’re a distributor of computer software. You are hoping to expand your business by distributing more products in Miami.

What can you do to achieve that goal? You can post online ads showing to prove that indeed, you were looking for new business contacts in the area.

And when you get there in Miami, meet a couple of those who have responded to your advertisement. Document your meeting by taking photos, or keeping the business cards of your prospects.

However, you should also look at the time spent for business-related activities during your trip. It would be hard to justify travel costs for a week-long trip to Miami if you only spent 2-3 days meeting with clients.  The IRS will likely call your attention if you declared that you spent just half of your time in Florida meeting prospective customers or dealers.

What if your residence is just a few hours away from Miami? Does that mean you can’t claim your travel expenses as tax deductible?

You can, as long as you can prove that you had to sleep or rest in Miami so that you can meet the demands of your work. Let’s say that you slept in the hotel where you held a meeting to avoid possible traffic problems. The IRS will consider your overnight stay in Miami to be business-related, and allow you to make a claim.

  1. Allocate your expenses

If you traveled for a business meeting but also went to see some old friends or visited tourist destinations, you will have to allocate your expenses. You can only deduct your business-related expenses, and not the costs that you incurred for personal activities.

For example, you rented a car to take you to Miami from New Orleans. Your business travel amounted to around 2,000 miles round trip. But on your way back to NOLA, you decided to take a detour to Jacksonville to visit your old college buddy.

Because the detour to your college buddy is personal and not business-related, you cannot claim your expenses for that part of the trip.

Generally speaking, you can’t claim the expenses of your spouse if he or she accompanied you in your business trip unless the presence of your significant other was necessary.

No, your spouse taking down notes for you during your trip isn’t justifiable. Your partner should have done something more critical, like serving as your interpreter, or even helping you close a deal.

  1. Keep your receipts and related documents

Lastly, keep all your receipts during the trip. You may even write down details at the back of the receipt, like the names of the business associates you met and the purpose of the meeting.

If your total expense during the trip is $75, you don’t need to show your receipts, though.

Don’t throw away other papers such as conference or seminar program. Those papers can justify your tax deduction claim.

 

Going on a business travel is like hitting two birds with one stone. Your firm not only stands to benefit from you embarking on a business travel, but you can also reduce your tax obligations.

You can meet a potential client during a business travel, or strengthen your relationship with your current customers. You can also attend a convention or seminar to enhance your skills, or learn a new one.

Moreover, you can write off business travel expenses like lodging, transportation, and meals, although the latter has a limit of 50 percent of the total costs.

The IRS, though, has been quite strict when it comes to business travel claims. You can fend off an audit by properly allocating your expenses, keeping receipts and related documents, and establishing the purpose of your travel.

If you’ll follow the tips mentioned in this article, then you should have no problems in claiming business travel deductions.

Hire Your Children To Save Taxes

Child labor is a subject that has a negative connotation in our society. For most people, it means depriving children of their childhood. It means forcing them to work when they should be at home watching TV, or playing in the fields.

But it is a different matter altogether if the child is employed by his or her parent’s company.

If you have a small business and you have children aged below 18 years old, it is highly recommended that you hire them as employees. It can be a very fulfilling experience to them. It can hasten their growth, develop a sense of pride and self-worth, and teach them to be more responsible.

Moreover, it can save your company thousands of dollars in taxes. It’s like hitting two birds with one stone—your children can be productive during their spare time and you andyour company can get to save a lot of money.

Hiring teen and young adults in a family owned business benefits both parents and the young ones. Parents get to save more as their businesses have lesser tax burden. Children, on the other hand, can be productive and get some extra money for their extracurricular and summertime activities.

Tax Benefits

There are several ways for your company to benefit from hiring your children as workers:

  1. The child’s salary is free from taxes.

You might know that the first $6,300 of income in a fiscal year is free from federal taxes. This is called the Standard Deduction. So if you hire a child as an employee of your firm, you’re basically keeping that amount in the family. Hire someone else and that $6,300 is taken out of you.

That money coming from your own pocket can be used by your son or daughter to buy a car, or go on a vacation. Even better, he can use it to support himself or his college education.

  1. The child’s salary will be tax deductible.

Let’s say that you are hiring your child with an annual pay of $6,300.  You can declare that amount as tax deductible from your business income.  The first $6,300 earned by a child working in his/her parent’s firm is not subject to tax. Yes, this means that your child’s earning will not only be subject to federal income tax tax but also state tax, FICA, or Medicare.

You, as the business owner, meanwhile, can declare that amount as fully deductible. This means that you will get a tax relief based on your child’s salary as an employee of your business.

For instance, your business is in the 35 percent tax bracket. You hire your 14-year old son to work in your office and help you with the filing of documents, or working  with the spreadsheets. For the year, he earns $6,300 in wages. He must also has no other sources of income.

You, as the business owner, stand to save $2,205 since the full amount of his wages will be deductible as compensation.

  1. No FICA taxes.

As mentioned earlier, your child’s salary isn’t subject to FICA tax. This means your firm won’t have to pay FICA taxes on your child’s wages.

However, there are certain requirements for your child’s salary to be exempt from this kind of tax:

  1. Your business is a sole proprietorship
  2. It is a husband-wife partnership
  3. It is a husband-wife LLC considered as husband-wife partnership for tax purposes
  4. It is a single member LLC treated as sole proprietorship for tax purposes

It should be noted that your child’s salary is not exempt from FICA taxes if your business is a corporation. FICA tax exemption is also not applied if the business is a partnership, or one or more partners are not parents of the child.

  1. Setting up retirement savings plan.

What most people don’t realize is that children under 18 can contribute to their own individual retirement account (IRA). This can be a great way for them to get a head start as far as saving and investing money is concerned.

Your child can contribute up to $5,500 to a traditional IRA. He can subtract the amount from their income for tax purposes. However, your child can’t make more contribution to what he earned in a year. So if he earned $5,000 in a year, the maximum IRA contribution he can make is $5,000.

  1. Shifting a parent’s higher taxed income to a child.

Since your child can save by a) having his income exempt from taxes and b) having the option to set up IRA on the income, you can then shift your higher taxed income to him.

Going back to our examples, your son makes $6,300 and then adds $5500 as a contribution to an IRA. Thus he has $11,800 shielded from taxes, and your business can write off that amount as a legit business expense that can reduce your gross income.

That’s the maximum amount that your child can make in a year sans tax. If you give him a higher pay than $6,300 in a year, the next $9,275 will only be taxed at a rate of 10%.

Thus, your son stands to have a tax of just $927.50 for the year on aggregate earnings of $21,075.

You’ll be wise enough to include that amount in your own income as you can incur a tax liability of $10,600. You can save up to $9,672 in taxes by doing so.

Guidelines

There are several things that you should know if you are to hire your kids as employees. Knowing these guidelines should keep the IRS from disallowing your company from claiming said tax exemptions:

  1. He/she must be a real employee.

Your children should be hired as bona fide employees. This means that they have work that is helpful and appropriate for your business. Typical jobs for children include routine office work such as typing jobs, stuffing envelopes, cleaning the office, answering phones, or making deliveries.  Tech-savvy teenagers can help in marketing a company through social media. Or they can help in maintaining the spreadsheets of the firm.

They can’t be hired for jobs that have no connection with your business, like mowing your lawn at home. Suffice to say, children shouldn’t be asked to do household chores and get compensated for it.

Since your child is considered as a real employee, he or she should fill out their timesheets. It is also recommended that they sign a written employment agreement that specifies the duties and work hours of the employee.

  1. The work must be age-appropriate.

The work assigned to your child should be age-appropriate. There’s a chance that a 8 or 9 -year old child can help in some tasks in the office like stuffing envelopes or even making deliveries. But it will be difficult for the IRS to believe that a child aged below that age can perform any useful work for your firm. Employing a 6 or 7 year old for photocopying work or filing can put you in trouble with the IRS.

It’s also a no-no for children aged 16 years and below to work in a dangerous industry. Hence if your business is heavy equipment contracting, you can’t assign your 15-year old son to the field.

  1. Child should comply with legal requirements.

Since the child is considered a real employee, he or she should comply with the same legal requirements as you would when you hire a stranger. Thus, he will have to apply for a Social Security Number and fill out IRS Form W-4. He or she should also complete Form I-9 of the U.S. Citizenship and Immigration Services.

  1. Compensation must be reasonable.

Simply put, your child’s salary should be consistent with market rates.

Many shrewd business owners would try to give their children a big compensation because it can give them more tax savings in the long run. It would enable them to shift much of their income to their kids who are likely to be in a much lower income tax bracket. But you shouldn’t attempt to do this as the IRS would eventually find out about this if they do an audit.

In paying your children, you should give them a reasonable compensation. The total compensation must include the salary plus all the fringe benefits such as health insurance and medical expense reimbursements.

To get an idea on how much you are to pay your child, you can call an employment agency to see the typical compensation for the type of work that your youngster will do in your business.

  1. Pay in cash.

It’s up to you to decide how much you would pay your son for the services he renders to your business. Just make sure that you pay him in cash if you don’t want to get in trouble with the IRS. Compensation in the form of foods and other things won’t cut it.

There was this case of a tax preparer in Washington who also owned an employment agency. She employed her three children aged 8, 11, and 15. The kids earned a combined $15,000 in two fiscal years for doing tasks like filing and stuffing envelopes. Their mom deducted their salary as business expenses. The IRS disallowed it.

Why?  It’s because the children’s wages was used by their mom to pay for their food, often pizza.  Also, she used the money to pay for their tutor’s fees.

While the mother argued that it was her children who asked her to spend their earnings that way, the Tax Court ruled in favor of the IRS. It noted that it is her parental obligation to provide food and support her children’s education, and the wages of the kids should not be used for these purposes.

  1. Be diligent about documentation and book keeping.

One way to ensure that this arrangement won’t backfire on you is to be diligent about the documentation and book keeping. Doing so would convince federal or state auditor that you reasonably employed your children for your business, and that your tax claims are legit.

Aside from getting all the state permits necessary to employ children, your company’s recordkeeping and payroll tax accounting must also be fool-proof. The payroll for your kids must be done in the same way that an employer would do the payroll for another employee. Paying a fair market rate, as mentioned earlier, would also satisfy the auditors.

  1. Your child should also help your business.

Finally, business owners should not only be concerned with the tax savings they’ll get when they hire their children. They must also be sure that their children can do the tasks assigned to them. The children should be able to help the business, and not just for the tax savings that the firm gets because of them.

Sure, they’ll reduce taxes by employing a child. But if the child doesn’t do a good job at work, then it would probably best to hire another individual to do the job for the firm.

Let’s say that a father hires his 15-year old son to help typing documents in his office. He’s able to save $3,000 in taxes for doing so. But if his son just lounges around the office and doing nothing, then the father didn’t really get the best out of this arrangement. It would have been better for him to hire another person who can actually help his company.

With the tax savings that small business owners can get, it really makes a lot of sense for them to hire their children during summer or even on weekends. The business owner not only stands to save on taxes, but also instils in his/her children values like hard work and responsibility.

If you decide to do this, you should ensure that you do things right. Get your children the necessary permits. Do your accounting cleanly. And give them real wages—not slices of pizza. If you do things correctly, you can save thousands of dollars in taxes while training your children who could be your successor one day.

2016 tax rates

2016 Tax Rates – Plan Ahead To Save

Many of you are getting your paperwork ready to file your 2015 tax returns but you may also want to review the latest tax brackets and standard deductions amounts for the upcoming 2016 tax year.  This can give you a head start for 2016 tax planning.

 

2016 TAX BRACKETS

INDIVIDUALS:

Over But Not Over Tax Rate
$0 $9,275 10%
$9,276 $37,650 15%
$37,651 $91,150 25%
$91,151 $190,150 28%
$190,151 $413,350 33%
$413,351 $415,050 35%
$415,051 And over 39.6%

 HEAD OF HOUSEHOLD

Over But Not Over Tax Rate
$0 $13,250 10%
$13,251 $50,400 15%
$50,401 $130,150 25%
$130,151 $210,800 28%
$210,801 $413,350 33%
$413,351 $441,000 35%
$441,001 And over 39.6%

 MARRIED FILING JOINTLY

Over But Not Over Tax Rate
$0 $18,550 10%
$18,551 $75,300 15%
$75,301 $151,900 25%
$151,901 $231,450 28%
$231,451 $413,350 33%
$413,351 $466,950 35%
$466,951 And over 39.6%

 MARRIED FILING SEPARATELY

Over But Not Over Tax Rate
$0 $9,275 10%
$9,276 $37,650 15%
$37,651 $75,950 25%
$75,951 $115,725 28%
$115,726 $206,675 33%
$206,676 $233,475 35%
$233,476 And over 39.6%

The IRS has also released its standard deductions chart for 2015. Everyone who pays taxes will get a small increase in their standard deduction amount.

 STANDARD DEDUCTIONS

Filing Status Standard Deduction Amount
Single $6,300
Married Filing Jointly $12,600
Married Filing Separately $6,300
Head of Household $9,300
Surviving Spouse $12,600

There are some important changes in 2016 tax code!

  • New Limit For Earned Income Credit =  $6,269 for those who have 3 or more qualifying children in 2016 (Married Filing Jointly)
  • Had a Foreign Income = The foreign earned income exclusion is $101,300 for 2016.
  • Personal Exemption =  $4,050 for this year.  Alternative Minimum Tax  (AMT) exemption amount is $83,300 (Married Filing Jointly) and $53,900 for singles.

How The IRS Tells The Difference Between Negligence And Tax Fraud

Cheating on your taxes is a crime. However, only .0022% of taxpayers are actually convicted of a tax crime. This percentage is surprisingly small especially when you take into consideration that the Internal Revenue Service estimates approximately 17% of taxpayers do not comply with tax laws in one way or another. Over the past ten years, the number of tax crime convictions has decreased.

The IRS reports that individual, middle income earning taxpayers account for 75% of the cheaters. Corporations account for the majority of the rest. The worst tax cheaters are usually workers from the service industry and other cash intensive businesses from handyman to professional doctors. For example, the IRS makes the claim that waitresses and waiters, on average, underreport their tips in cash by 84%.

How Taxpayers Cheat

Many of the people who cheat on their taxes deliberately underreport income. A study performed by the government found that the bulk of people that underreported income were clothing store owners, self-employed restaurateurs and car dealers. Salespeople and telemarketers were next followed by doctors, attorneys, accountants and hairdressers.

A far distant second were taxpayers that are self-employed who over deduct their business expenses including car expenses. The Internal Revenue Service has surprisingly concluded that a mere 6.8% of tax deductions are actually overstated or false.

When you are caught cheating on your taxes by an IRS auditor, you can just have to pay penalties and civil fines or your case can be referred to the division of criminal investigation.

Negligence or Fraud?

IRS auditors have been trained to find tax fraud, an act done willfully with the intent to defraud the Internal Revenue Service. That is beyond making an honest mistake. Examples of fraud include keeping 2 sets of books, using a fake social security number or claiming dependents when you have none. Even though auditors have been trained to look for tax fraud, they do not start off suspecting it. They have an understanding about how complicated the tax law is and expect all tax returns to have a few errors. Normally, they’ll give you the benefit of the doubt and they will not come after you if they believe you made an honest mistake.

If you made a careless mistake, you could receive a 20% penalty on your tax bill. While this is not great, it is better than a 75% penalty for fraud. Even to the courts and the IRS, the line between fraud and negligence is not clear. Auditors are able to spot common problems on tax returns that constitutes fraud such as fake receipts, altered checks and businesses without records.

The chance of being convicted of a tax crime is extremely low but it does occur. If you are being accused of fraud, you need to hire the best legal counsel specializing in tax crimes.

Tax Advantages of being a home owner

home

 

When you own a home you are able to deduct a lot of home related expenses if you itemize your deductions. That means that you will have to file Form 1040 including schedule A. Below is a look at some of the taxes advantages when you own a home.

Mortgage Interest

All of the mortgage interest you pay each month is tax deductible unless you have a loan over $1 million dollars. That is great news since most of the money you pay goes toward interest.

Even if you refinance your home, get a line of credit or get a home equity loan, the interest is generally fully tax deductible on equity debts that are $100,000 or under.

Even second homes are fully tax deductible. It can be a home, RV or boat as long as it has facilities for sleeping, cooking and a bathroom. You can even rent your second home as long as you stay in your home 14 days a year or more than 10% the amount of days you rent the property (whichever is more). If you do not stay in your home that long, the IRS will consider it a rental property and you will lose your mortgage interest deduction.

Points

If you paid points on your mortgage so you could get a better rate, you can get a tax break. When you purchase your main residence, the IRS will let you deduct all of the points during the year they were paid.

When you refinance your home, you still get a tax break but the points usually get deducted over the loan’s life.

For lines of credit or home equity loans, you can deduct the points the same year they are paid if the money is used to do work on the home. If you use the money to do anything else, the points will be deducted throughout the term of the loan.

On second homes and vacation residence, the money paid in points must be amortized over the term of the loan.

Property Taxes

Another big tax break you will receive is deducting the amount you paid for property taxes during the year. All of your property taxes that were paid will be itemized as an expense on IRS Schedule A.

Sell Your Home

If you sell your home, you can avoid some of the taxes on any profit you make. A sales gain up to $250,000 for individuals and $500,000 for married couples is tax free if the property was owned for 2 years and has lived in it 2 years before the sale. If you do not meet the residency and ownership requirements, you will owe tax on all of the profit.

Unforeseen Circumstances

If you sell your home because of unforeseen circumstances, the IRS provides some tax relief for people who have to sell before they fully qualify for the tax break.

Unforeseen circumstances include:

– Job loss
– Divorce
– Death
– Multiple births during the same pregnancy
– Employment changes that make it hard for the owner to pay mortgage and cover all basic living expenses.

Also, you can receive a partial exclusion if you have to sell because of damage to the residence from a man-make disaster, if the property is converted involuntarily, taken by the government or natural disaster. Check with your tax professional for more information.

Foreclosure

Under the Mortgage Debt Relief Act, homeowners that were either foreclosed, had their debt reduced in a restructuring of their mortgage or had a short sale do not have to pay taxes on the canceled debt as taxable interest. This tax law is only in effect until the end of 2013 unless Congress takes action.

What Is A Bitcoin?

Bitcoin

A Bitcoin is a form of digital currency that is not controlled by the government or any other entity. It was invented in 2009 by an entity or person operating under Satoshi Nakamoto. It is a completely anonymous system. It exists on a peer-to-peer digital forum. Consumers purchase the Bitcoins on the forum and they store them online is a Bitcoin wallet totally free from intervention of the government.

Bitcoin promises a totally anonymous currency system that has eliminated any possibility of inflation bred by the government. The Bitcoin system is based on cryptography and complicated mathematics. Over the past year, Bitcoins popularity has soared exponentially in a speculative market that has created a Bitcoin bubble. The supporters consist of a population of select, tech-savvy, anti-government users due to the fact there is no digital trail.

Crypto-Currency

The reason Bitcoin is a crypto-currency is because its existence is only online and is therefore free of systemic manipulation by the banking system.  Bitcoin mining is the process of creating Bitcoins and are entirely regulated by a network of holders of Bitcoins’ computers. All Bitcoin transactions and Bitcoin transfers happen internationally without banking fees, taxes, time delays or constrictions.

The Bitcoin Wallet

The way you store the Bitcoins you acquire is in a virtual Bitcoin wallet. These wallets are usually established through third party sites or using a computer software. Bitcoin wallets do not invest the money you have deposited in your wallet the way a bank does when they are holding your money. Since Bitcoins are free of any federal interference, the currency is not insured federally by the FDIC.

After you establish your Bitcoin wallet, you officially belong to a network where you can trade and make transactions of Bitcoins. For transfers, you just have to use the other person’s anonymous ID number. It takes several minutes to process the transfer.

Largest Known Investors In Bitcoins

The Winklevoss twins are outspoken believers in Bitcoins. They have spoken out that they reason they have chosen to use the Bitcoin currency is because they have enormous faith in the mathematical based framework free from human error and politics. These extremely wealthy twin brothers got their notoriety from making the argument that they were instrumental in the meteoric rise of Facebook. They were portrayed in the movie “The Social Network”.

Bitcoin Mining

Bitcoin mining is the first step to create Bitcoins that holders can trade. Power computers create Bitcoins using the solution of complex mathematical equations. By design, the equation are exceptionally complex and labor intensive to limit the existing Bitcoin supply.

Bitcoin mining has a downside. It uses an extraordinary amount of energy with computers that are excessively powerful in order to solve these complex equations. It is estimated that 24 hours of Bitcoin mining equates to $147,000 of electricity use just to operate the hardware for mining.

What Can You Purchase With Bitcoins?

Almost anything you can think of can be purchased with Bitcoins. The Bitcoinstore.com is a retailer that has the most online traffic. There was an online black market retailer that helped to make the Bitcoin popular known as Silk Road. Before it was taken offline, you could buy any imaginable drug totally anonymously because the Bitcoin is untraceable.

Many retailers are beginning to accept Bitcoin as a payment method. You will more and more retailers showing the Bitcoin symbol to let people know they are accepting Bitcoins. People are using the crypto-currency to purchase everything from ordering pizza to clothing to paying bar tabs. Some hotels are also beginning to take Bitcoins for hotel stays, dining, room service and drinks.

The Bitcoin Craze

How Big Is The Bitcoin Craze? Bitcoin surpassed a $1 billion total valuation for all existing Bitcoins on Apr. 3, 2013, an all-time high. The high valuation proved that the Bitcoin craze was in the middle of a bubble that had been growing with the ever increasing media coverage since inception. In 2010, if you owned $100 worth of Bitcoin, the value would have increased to $72,500 only one year later. In a ‘Gawker’ article written one week later helped the value skyrocket to $250,000. On Apr. 3, 2013, that same $100 bought in 2010 was worth approximately $1 million dollars.

Is The Bitcoin Bubble Unstable?

The Bitcoin is a very volatile market as you can imagine based on the extraordinary rise in value after only a few years. On Apr. 9, 2013, it reached a new high value at over $200 for each Bitcoin. On Apr. 10, just one day later, the value dropped to $105 for each Bitcoin. The reason that the Bitcoin market is instable is because the speculators determine the value based on its potential investment value. It is not determined by the amount of Bitcoin use or trade.

Are Bitcoins Secure?

Bitcoins that are stored in your Bitcoin wallet, should be secure because of the currencies anonymous nature. The problem is if your wallet is hacked or if you trust a fraudulent person with a transfer, it is not possible to recover your losses or find the person who mislead you.

Can My Wallet Get Hacked?

Using a third party Bitcoin wallet makes it unlikely to get hacked; however, there is still a risk that it can be hacked causing you to lose all of your Bitcoins. Although Bitcoin’s cryptography is declared secure because it is extremely complex, it is a public source which means hackers all over the world can try to hack it. The problem with Bitcoins is you either have to trust a third party to store your Bitcoins or you can use your own software which increases the chance of being hacked. In 2011, a Bitcoin holder went to bed with his computer on. When he woke up, his 25,000 Bitcoins were gone. There was no chance of them ever being recovered.

Will Bitcoins Fade Away?

It is illegal to create currency that competes with the United States currency so it is not clear if using Bitcoins is level. The Bitcoin supply is intended to be scare which makes it practically impossible to use Bitcoins on an international level. It has been said that the Bitcoin cannot succeed long term because the ever increasing value of the Bitcoin would be disastrous to the economy if millions started regularly using Bitcoins.

Bitcoin is nothing less than a roller coaster ride

Now here’s a chart of Bitcoin over the past year, using data from Coinbase, a leading Bitcoin exchange:

BITCOIN PRICE