Tax Tips Blog

Several of my clients are concerned about how the new Texas Franchise Tax will affect their business. This new tax is a major revision and adds a lot of complexity.

Entities will no longer be taxed based on their modified net income or taxable capital, but instead on their profit margin. There are still a few rules to iron out, but Texas has issued temporary guidelines.

In general, although more entities will be reporting their income to Texas, many small businesses stand to reduce or avoid this tax completely.

Currently, Texas assesses a franchise tax on all businesses EXCEPT:

• sole proprietors (who are not single member LLCs)
• general partnerships
• limited partnerships
• professional associations (physicians, dentists, and other medical professionals) and
• non-profit entities.

For tax years beginning January 1, 2007, all for-profit entities who are seeking state liability protection will be subject to the tax. The two groups that will be subject to this tax for the first time are physicians and other medical professionals who organized as a professional association and limited partnerships.

All taxable entities must file a report, even if no tax is due. Currently, the Texas Franchise tax provides for a dual calculation, but most of my clients and most entities who are subject to this franchise tax, the tax is based off their modified net income.

Currently, the Texas franchise tax kicks in if your entity has “receipts” (or revenues) of $150,000 or more. Once you trigger the Texas franchise tax, all net income is subject to a tax rate of 4.5%. You can reduce the tax with expenses, including guaranteed payments or salaries to owners.

Beginning with 2007 tax years (reported in 2008), the hurdle (receipts) rate is raised to $300,000 from $150,000, so fewer companies will trigger this tax. The franchise tax rate also is reduced to 1% for most taxpayers and 0.5% for wholesales and retailers. This rate will be applied to the companies taxable margin, not net income.

Let’s take a look at how this might affect two of my clients. The first client we will look at is a physician, who has never been subject to the Texas Franchise Tax as he incorporated under the Texas Professional Association Act. He is anticipating gross revenues of $600,000. Medical professionals are allowed to reduce this amount by revenues received from:

• Medicaid
• Medicare
• CHIPs
• Workers Compensation Claims
• TRICARE and
• the actual cost of uncompensated care.

My client had to revise their general ledger to easily separate all these payments in order to make things more efficient come tax time. The hardest part is obviously determining the actual cost of uncompensated care. After my client deducts all these exempt revenues his Texas Revenues totaled approximately $480,000.

Service providers get to elect each year, if they would like to reduce this amount by either the W-2 wages they paid to themselves and all their employees (not to exceed $300,000 per person) or 30% of their Texas Revenues.

My client estimates paying W-2 wages of approximately $390,000 and employee benefits of $15,000. This would reduce my client’s taxable margin to $75,000 and Texas Franchise tax is computed at $750, but no tax is due if you owe less than $1,000. My client will still have to file this form, but he will still not be subject to the Texas Franchise Tax.

The second client we will look at is a retailer. He is anticipating gross sales of approximately $2 millions with a cost of goods of nearly $1 million, making his margin approximately $1 million. Since he is a statutory retailer he will be paying tax at 0.5% of this amount or $5,000. Although this sounds like a lot of tax, under the current Texas Franchise Tax System he will be paying on his net income, which is almost twice as much tax owed.

Both of these clients anticipate saving tax dollars under the new Texas Franchise Tax system. Just remember this won’t take affect until your report your 2007 income.

Are your children attending a day camp this summer so you and your spouse can work or go to school full time? If so, you may be able to get a tax credit for the fees you paid for them to attend day camp.

A tax credit reduces the amount of tax you pay dollar for dollar, unlike an itemized deduction, which reduces your tax bill based on your tax rate. In 2006, the child and dependent care credit can save you up to $3,000 if you spend that much on care for one child under age 13. If you have more than one child in that age group who qualifies, the credit can save as much as $6,000.

Money spent on care for disabled older children also is covered. For all eligible children, the tax credit ranges from 20% to 35% of the money spent on eligible child care.

Summer day camps are considered eligible child care. Overnight camps do not qualify.

As with most credits and deductions, the higher your income, the lower the credit available. If your family income is over $43,000, the credit rate is 20%.

How would this work?If you spend $500 sending your eligible children to day camps this summer, so you and your spouse can work, and your income is greater than $43,000 you will save $100 in taxes. If you spend another $5,500 during the school for before and/or after school care, such that you and your spouse can work, you will save $1,200 in taxes.

If you are self-employed and considering hiring some part-time help you should consider hiring either your children or your retired parents. Depending on their abilities and skills your family members can clean your office, file papers, answer phones, design or update your business website, mow the lawn outside your office or just about anything that relates to your business.

No matter who you hire, you need to do it properly in order to get the deductions you deserve. First, make sure that you pay them reasonable compensation for the work you are having them do. The courts already have ruled that you can deduct taxes for any “reasonable wages” that you pay your children ages 7 or older to perform duties related to your work. If you previously had someone else doing this same work pay your family members what you were paying them. If this is a new position then a place like Salary.com may be useful in determining what the current pay level is for these types of services. Document the job description and how the salary was determined.

NOTE: Child labor laws vary from state to state, so before you hire a child review your state’s child labor laws. The federal labor law applies in all states; if the state and federal law differs, the stricter one must be followed. You can see a summary of the Texas Child Labor Law here: The Texas Child Labor Law.

Have all your employees, including your children and parents, complete forms W-4 and I-9. Form W-4 will tell you how much you have to withhold from their paycheck. Form I-9 provides proof of their eligibility to work in the United States. Both of these form can be downloaded from the IRS website.

All your employees should be either using a time clock, punching in and out or writing their time down on a time sheet. Pay all your employees with a business check. Your children can always endorse the check over to you for cash to replace their allowance or accumulate the money for college tuition.

At the end of the work year, file a form W-2 with the IRS for each employee.

Okay, so where are the tax benefits?

If your business is unincorporated (a sole proprietorship or a LLC taxed as a sole proprietorship) and your children are under age 18, you will not have to pay Social Security or Medicare tax and, normally, no state unemployment or disability taxes, either. Assuming this is your children’s only source of income, the wages you are paying them are considered “earned income,” which means that the first $5,150 received by each child in 2006 is tax-free.

So, let’s say I have three children, ages 12, 14 and 16. I hire each one to work for me in my unincorporated business and pay each one $9,150 in 2006. Because they are all under 18, I pay no Social Security, Medicare or state unemployment/disability taxes. Because of the standard deduction, in 2006, the first $5,150 earned by each child is not taxed, but could be saved to help pay for their college education (or buy their first car). The next $4,000 could be sheltered by setting up IRAs for each child. The net result is that I have paid my children a total of $38,600 ($9,150 x 3) that I can deduct from my business income and is tax-free to my kids. If I am in the top marginal tax bracket of 35%, I’ve just saved $13,510 each year in federal taxes alone.

Okay, but are there tax benefits to hiring my parents?

Certainly. If you employ a parent, his or her wages are subject to income tax withholding, Social Security and Medicare taxes, but not Federal or State unemployment taxes. The wages you pay your parents are still deductible to you; therefore you will save on your federal taxes the same way you did in the above example with your children.

NOTE: If your parents were born January 2, 1941, through January 1, 1942, their full retirement age for retirement insurance benefits is 65 years and 8 months. If they work and are full retirement age or older, they may keep all of their Social Security benefits, no matter how much they earn. If they are younger than full retirement age, there is a limit to how much they can earn and still receive full Social Security benefits. If they are younger than full retirement age during all of 2006, they will deduct $1 from their benefits for each $2 they earned above $12,480. If your parents attain full retirement age during 2006, they will deduct $1 from their benefits for each $3 they earn above $33,240 until the month they attain full retirement age.

Hiring your children or parents doesn’t increase your chances of being audited, and it has the potential to increase family wealth substantially.

Most taxpayers are aware that if they donate cash or personal items to a qualified organization they may be able to claim an itemized deduction for the fair market value of their donation. It is also pretty common knowledge among taxpayers that you are not allowed a deduction for the value or time of the services you provide. What many tax payers commonly neglect to deduct are the following…

You can deduct 14 cents a mile for each mile you drive for charitable purposes, plus parking fees and tolls. This includes your mileage to Goodwill or Salvation Army to drop off your old clothes and furniture. If you’re a weekly (or monthly or occasional) volunteer at a Hospice, Hospital, Cancer Center, etc. this mileage is all deductible.

Alternatively, you could deduct the actual costs of transportation, like gas, oil changes, parking fees, and tolls, but you would need receipts to prove them.

If you incur expenses while traveling away from home while performing services for a charity, including out of pocket costs for round-trip travel, taxi fares, and other costs of transportation between the airport, bus station, train stations and hotel, plus lodging and meals are deductible in full.

NOTE: These expenses are only deductible if there is no significant element of personal pleasure associated with the travel, or if your services for a charity do not involve lobbying activities. The cost of entertaining others on behalf of a charity, such as wining and dining a potential large contributor are deductible, but the cost of your own entertainment or meal is not deductible.

You can deduct the cost of your uniform (Hospital Scrubs, Cub Scouts, etc.) when doing volunteer work for the charity, as long as the uniform has no general utility. The cost of cleaning the uniform can also be deducted.

Remember, to document you charitable giving such that you can receive a tax break at the same time. Keeping a log book is the easiest way to make sure you don’t miss a deduction.

And make sure that the organization you are providing these services to a qualified organization. Publication 78, Cumulative List of Organizations described in Section 170(c) of the Internal Revenue Code of 1986, is a list of organizations eligible to receive tax-deductible charitable contributions. You can find this publication here.

Now that it’s summer I’m sure you’ve gotten together with friends and neighbor’s and at least one of them has bragged about being able to deduct their vacation. You probably just smiled and then either wondered if it was really legal or when the IRS was going to come knocking on their door.

Well, it is possible to legally deduct a business trip and the IRS doesn’t have a rule against having fun while on business. The important thing to remember is to properly document it.

In order to satisfy the IRS, you should make a business appointment before you leave for your trip. You can not just go on vacation and hand out your business card and expect the IRS to let you deduct your trip. You must have at least one business appointment before you leave in order to establish the “prior set business purpose” required by the IRS. So if you want to deduct your vacation, set up business appointment for each city or destination you plan to visit. If you have your own business you could look in the phonebook for possible new vendors in all the cities you plan to visit. Then send out postcards to each vendor saying that you’re coming to town and looking for new vendors and then interview those who respond to your postcard when you arrive in town. If you use this approach then you MUST keep one postcard for your files, the list of places you sent your postcard and copies of all correspondence with potential new vendors noting your appointment times, etc.

The second thing you needs to consider before you leave is that in order for your travel to qualify as “business travel” and thus be deductible, you have to be traveling for business. The IRS says you are traveling for business whenever you are sleeping overnight in a location that is not your home. For every day you are on business travel, you can deduct 100% of lodging, tips, shoe-shines, laundry and dry cleaning, car rentals, and 50% of your food. So if you spend three days meeting with potential vendors and you spend $50 a day for food, you can deduct 50% of this amount, or $25. According to the IRS, no receipts are required for any travel expense under $75 per expense. The only exception would be for lodging. You always need a receipt to prove lodging. But if you pay $6 for drinks an the plane, $6.95 for breakfast, $12.00 for lunch, $50 for dinner, you do not need receipts for anything since each item was under $75.

NOTE: It is extremely important to document all your expenses items. All expenses for traveling should be documented in a business log book. Not only are your on-the-road expenses deductible from your trip, but also all laundry and dry-cleaning costs for clothes worn on the trip. This means that your first dry cleaning bill that you incur when you get home will be fully deductible. Make sure that you keep the dry cleaning receipt and have your clothing dry cleaned within a day or two of getting home.

If you have a business day on Friday and another one on Monday, the IRS will allow you to deduct all on-the-road expenses during the weekend. So if you make at least one appointment on Friday and one on the following Monday, then even if you have no business on Saturday and Sunday (other than trying to enjoy your vacation), you may deduct on-the-road business expenses incurred during the weekend.

The IRS allows you to deduct transportation expenses if business was the primary purpose of your trip. This is determined based on how many days you conduct business on your trip. The majority of the days in the trip must be for business activities or you cannot make any transportation deductions. It’s all or none.

For example, let’s say you spend six days in San Diego. You leave early on Thursday morning. You have a business seminar on Friday and meet with potential new vendors on Monday and fly home on Tuesday, taking the last flight of the day home after playing a complete round of golf. All of these days would be considered business days. Thursday is a business day, since it includes traveling. It doesn’t matter if you do anything for pleasure as well. Friday is a business day because you attended a business seminar. Monday is a business day because you met with potential new vendors in prearranged appointments. Saturday and Sunday are sandwiched between business days, so they count. Tuesday is a travel day. So every day was deductible.

Using the same facts as the previous example you managed to accrued six business days. This means you could spend another five days having fun and still deduct all your transportation to San Diego. The reason is that the majority of the days would be business days (six out of eleven). However, you can only deduct six days worth of lodging, dry cleaning, shoe shines, and tips. The important point is that you would be spending money on lodging, airfare, and food, but now most of his expenses will become deductible. With proper planning, you can deduct most of your vacations if you combine them with business.