Tax Tips Blog

Dan asks:I was employed by Company X from 2001 to June 2006, when I resigned. I had vested stock options and I purchased the stock options one month after I resigned in July, 2006. My purchase price was 10 cents a share and the estimated fair market value at the time of the purchase was the same, 10 cents a share. I purchased about 89000 shares. At the time I purchased the stock options I received a form letter from company X for an 83(B) Election Notice. However, I did not submit anything regarding my stock purchase to the IRS. I still have the form letter. The form letter states my purchase price and the fair market value at the time of purchase. I expect the company to do an IPO later this year, and the expectation is that the price per share will be well above my purchase price.

1. Should I submit the 83(b) form to the IRS at this time?
2. Is it too late to submit the form, i.e., is it considered part of my tax return?
3. Do I need to amend my tax return with the attached form or something like that?

thank you

My response: Hello Dan, Section 83 applies any time property is paid in exchange for services. The Section 83(b) election can be made when the property received was nontransferable and subject to a substantial risk of forfeiture. Stock is considered nontransferable if you can sell, assign or pledge your interest in the stock to any person other than your employer and the person receiving the stock must give up the stock or it’s value if the event causing the substantial risk of forfeiture occurs. Stock is considered to be subject to a substantial risk of forfeiture if your rights to the stock were restricted upon your future performance (or lack of performance) of substantial services. If the stock was transferable and not subject to a substantial risk of forfeiture then your shares were vested. If your shares were vested when your option was exercised, then no election is required. The transaction is taxable on the date of exercise of the option, assuming the option was a non-qualified stock option. If your shares were not vested when your option was exercised, then you have the option of making a Section 83(b) election to reduce your taxes. The Section 83(b) election is made by filing one copy of a signed statement with the IRS Service Center where you file your individual return and by attaching another copy of the statement to your tax return for the year of receipt. Copies of the election statement must also be filed with your employer. The election must be made no later than 30 days after the date the property was transferred. An automatic extension is not available. Once the time period has passed to make a timely election, the opportunity is lost. No late election is allowed. The election cannot be made on an amended return. If the election isn’t made, ordinary income is reported for the excess of the fair market value of the stock over the option price when the stock becomes vested. Best wishes, Gina http://GLGcpa.com

Steve asks:For income tax, I usually adjust the tax withholding on my salary once or twice a year so that I meet one of the safe harbors. However I sold a rental property which will suddenly give me a lot of additional income. I’ve adjusted my withholding upward somewhat, but I’m worried I won’t be able to cover my whole liabiity this year. Thus, I’m thinking I should make an estimated tax payment–but how exactly do I do that? What kind of a penalty could I be faced with otherwise? Thank you in advance, Steve

My reply: Hello Steve. Thanks for visiting.

Usually once set, withholding will automatically adjust for increases or decreases in wages and usually will be more than your prior year’s tax. It’s sort of an automatic “safe harbor”. Because of this many people, after receiving a tax refund, adjust their withholding so they will no longer be giving the IRS an interest free loan.

Some taxpayers go as far as reducing their withholding to try and meet 90% of their current year’s tax, one of the available safe harbors. Unless your prior year’s tax was considerably more than you expect this year’s tax to be, this method is usually only recommended to those taxpayers who estimate their tax liability on a quarterly basis.

If your withholding is less than last year’s tax, or 90% of this years tax you must either increase withhold some more or make an installment payment, enough to to bring this year’s payments up to either safe harbor level in order to avoid a penalty. Thus, if you have increased your withholding this year such that now it is going to be more than your last year’s tax (110% of last year’s tax if your last years AGI was over $150,000 ) you won’t have a penalty, even if you owe taxes when you file your return.

If you find that you need to make an estimated tax payment I strongly recommend that you seek the help of a qualified tax professional because you will also have to file Form 2210 (at the end of the tax year) and annualize your income on a quarterly basis to prove that you didn’t owe the taxes sooner than you paid them.

If you wish to go this on your own you would complete Form 1040ES. You can download a copy of 1040ES from the www.IRS.gov site.

Best wishes, Gina

Bryan from VA writes:

Hello Gina,

I have been reading your blogs, and I thank you for some very informative reading.

Lately I have become increasingly interested in starting my own small business. I am looking for advice as to how I should go about doing this. Before taking this risk, it would help me to have you provide me with some steps or processes I need to look into before taking this risk. I am currently in the military, and I am trying to arrange a means of additional income to offset the military - civilian pay gap. For myself as a network engineer I earn less than half of the average civilian of like experience, and qualifications.that could help me in this area?

This may be a premature question, however any advice would be appreciated.

- Bryan

My reply:

Hello Bryan! Thank you for writing. I’m glad you enjoy my blog. I tried to email you this reply, but your email doesn’t seem to be working, so I’m hoping you’re reading this as well.

I’m excited to hear that you’re thinking about starting your own business. It’s not an easy thing to do nor decision to make, but obviously you’ve already made some tough decisions in your life, since you choose to enter the military.

When considering starting a business the first question that I believe you need to answer is whether or not your business idea will work. Contact companies and start your research. Ask them how they are currently handling their network, what’s working and what isn’t. Have they ever considered hiring a consultant to help them? Why or why not? Basically, you’re trying to find out if you will be able to sell your service and sell it for a profit.

Once you have figured out that there’s a need for your service, then it’s time to for you to write your business plan. There are many websites, books, and consulting firms who can help you write your business plan. The main aspects of your business plan include description of what your company is going to do, the research you obtained about the market (pretty much what I described above that I believe you should do before you start writing your plan), how you plan on organizing and managing your company, how you plan on marketing your company, how you plan on selling your services (or products), what you expect your start up cash, equipments, furniture, etc. will be, what you expect your total start up costs will be, your anticipated budget and your financial forecast.

Perhaps it’s because I’m a CPA or perhaps it’s because I’ve seen too many businesses with great ideas fail, but I cannot stress enough the importance of your financial budget and forecast. Most of the start ups that I see fail, have failed due to insufficient funds. Make sure you have a very good idea of how much it will cost to start your business and then add a cushion of error, because no matter how carefully you plan, there always seems to be some expense that you didn’t anticipate. Make sure you know what your break-even point is, what do your sales have to be to cover your expenses? How much money do you have? How long will your savings keep your business going while you’re ramping up your sales? Is this long enough to establish your business? If not, then you need to look into obtaining financing. This will not be easy, but it can be done, either through a bank or the Small Business Association.

The next step is to plan the opening of your business. You need to decide on a business name, entity structure, obtain any licenses or permits that your business may require, gather your list of advisors (CPA, lawyer, insurance agent, mentor, banker, etc.), start purchasing any furniture, equipment, tools, etc. that you may need, advertise and open your doors (I may have left out a thing or two here, but I think you get the idea).

I hope what I’ve written has been helpful.

Best wishes,

Gina

Now that you’ve organized your business records you need to develop a bookkeeping system.

A bookkeeper’s job is to record your books of original entry. This means they write checks, create invoices, make out deposit slips, try to collect on old accounts and deal with creditors. For most start-ups and small businesses this “bookkeeper” is also the owner. Most owners want and need to spend time managing their business and not doing their books. For this reason, you need to create a bookkeeping system that is efficient, accurate and cost effective. Your bookkeeping system will either be a manual system or a computerized system.

Manual System

Many small businesses do not need a computer for their business operations. In these situations, it is rarely cost effective to purchase a computer to perform your bookkeeping tasks. When you purchase a computer to do your bookkeeping your business you will be incurring not only the cost of the computer, but also the cost of virus protection software, the cost of firewall software, the cost of your backup method, the cost of your bookkeeping software, and ongoing upgrades and maintenance costs.

For those businesses who decide to forgo the computer I like to recommend that they use a “one-write” also called a “pegboard” system for their bookkeeping. A pegboard is used to align one-write forms (like checks, deposit slips, invoices, etc.), such that as you write on the form the information is automatically entered into the appropriate bookkeeping journal. Checks are automatically recorded in your disbursement journal. Deposits are automatically recorded in your receipts journal. This system allows you a means to keep a running checkbook balance and a place to put your general ledge code.

I have found that clients like a one-write system because it is easy and always available. They do not have to go to the computer to write a check and they don’t have to figure out what computer report to view to find a previous check that they wrote. They have the option of coding the checks at the end of the month or the end of the year, instead of being put on hold until the right general ledger account is determined. In addition, it is difficult to mess up your books with this method, you’d pretty much have to lose the journals.

Computerized System

If you need a computer for your other business operations, then it may be cost effective to have a computerized bookkeeping system. This is usually true because you already had to pay for the computer, anti-virus software and firewall. The only other major expense will the cost of the bookkeeping software that you choose. For new small businesses who are unsure of their income potential, I like to recommend any of the following free software packages:

• Choice Accounting,
  
• QuickBooks Simple Start,
• Microsoft Office Accounting Express
  

but any system that you understand and will use regularly and correctly will do just fine. The key is that you need to remember to enter everything into the computer accurately.

Conclusion

Whether you determine that a manual or computerized system is right for your business (or which accounting software is best for your company), the important thing to remember is that the bookkeeping functions are extremely important to the success of a business and should not be taken lightly. The books of original entry are summarized and used to prepare financial statements and tax returns.

A good accountant gives you advice based on reading your financial statements and tax return. If your books of original entry are not accurate then your financial statements, tax returns and the advice your accountant is giving you based on them will not be accurate either.

Seth writes: I work several times a year as an independent contractor for a company. I travel to various cities and deliver lectures. I receive a set fee for each lecture. In the past, I always submitted my receipts for my travel expenses and was reimbursed by the company. At year end, the only income ever reported to me on my 1099-Misc from this company was from the lecture fees. The money received for my reimbursement expenses was not reported. I was just been notified that this year the income I receive from reimbursed expenses will be reported on my 1099-Misc. Does this change in reporting mean that I will have to pay income taxes on this company’s reimbursement of meals since 50% of meals is not deductible? Thanks in advance for any help. Seth

My reply:Hello Seth and thanks for visiting.

Since you are an independent contractor being reimbursed by your client (the company), and if you adequately document those expenses to your client (the company), then you are not subject to the 50% limitation.

In this situation the 50% limit applies to your client (the company). You can read more about this in IRS Pub. 463, Travel, Entertainment, Gift and Car Expenses, www.irs.gov/pub/irs-pdf/p463.pdf.

Best wishes, Gina

Ryan asks: I’m retired with a federal pension and social security. Financially I do not need to work, but I miss it. I really enjoyed working, but I don’t want the pressure of a full time job anymore. I’ve been told that if I set up a foundation, I can freelance, doing the same work I use to do, only instead of having people pay me, ask them to donate the money to my own foundation. I’ll get to continue to do the work that I enjoy. Technically I will not have any earnings, so I won’t have to pay any taxes on the money I earn. I will get to direct 100% of my earnings to charities of my choosing. And everyone who hires me will get a tax write-off, so it will work great for everyone. My question is, how do I go about setting up this foundation?

My response:Hello Ryan!  By any chance does your idea sound a little bit too good to be true? Well it is.

In the situation you described, you would be providing your services as an independent contractor (note how many times you referred to the income as “earnings” - that should have been a hint that it was taxable).

As far as tax law is concerned, you are not allowed to “assign income”; thus anything you earn are your earnings to report. In the case you described above you would be reporting your earnings as a sole proprietor and you will owe federal taxes and self-employment taxes on any net income from your activity. If you are younger than full retirement age as far as social security is concerned it may affect your social security benefits.

The fact that you wish to donate your earnings to charity, whether that be your own foundation or another charity, is irrelevant; thus, under the circumstances that you described I don’t think you would like to set up a foundation. If one were to want to set up a foundation, a qualified attorney can help you do so.

Best wishes,

Gina

Emma asks:My husband and I would like a bigger home. The houses we’ve been looking at are either slightly beyond our reach, or affordable but in need of work. My mom would like to loan us $48K to $60K at zero percent interest. (The exact amount is yet to be determined.) Does the IRS consider the forgone interest to be a gift? Any way to avoid it? Possibly relevant facts:

• Mom plans to give my 2 siblings $12K/year for at least the next five years.
• In lieu of giving me $12K, should would reduce my loan balance by $12K until the loan is paid off.
• She and I would prefer that her name not be on the deed.
• The money will be used for down-payment and remodeling (if needed)
• I can qualify for the mortgage on my own, if need be. But the monthly payments would be higher than I’d like.

If the IRS considers the foregone interest a “gift,” and she forgives $12K of the loan, then her total gift to me will exceed $12K and I’ll have to pay gift tax, right? Can Mom “give” the foregone interest to my husband, rather than me? Are there other tax implications we need to consider? Any suggestions will be appreciated. Thank you.

My response: Hello Emma! Thanks for visiting my site.

The IRS does consider forgone interest to be a gift. The interest amount on a zero percent (0%) loan is imputed based on the Applicable Federal Rate (AFR). The IRS revises AFRs monthly. For your purposes you would use one of three AFRs:

• Short Term AFR is used if your loan has a term of three (3) years or less.
• Mid Term AFR is used if your loan has a term greater than three (3) years but less than nine (9) years.
• Long Term AFR is used if your loan has a term greater than nine (9) years.

You can find an index of Applicable Federal Rates on the IRS website.  The best way to avoid the imputed interest would be to charge an interest rate that is at least equal to the appropriate AFR.

If your mother were to give you $12,000 per year in addition to the imputed interest she would be exceeding the annual gift exclusion limit and she would have to file a gift tax return to reduce her lifetime exemption. Most likely no tax would be due, as tax is not due until she exceeded her lifetime exemption.

Even if your mother’s name is not on the deed you should have a signed loan contact with her. It would need to be treated just like any other legitimate business deal.

If both you and your husband sign theses papers documenting the loan, both the interest and the annual gift would be made to both of you, probably 1/2 each. This would solve the gift tax issues for your mother, but it may raise some issues with your siblings since you would be receiving a larger gift than they would.

In addition to gift tax concerns, your mother may also have income tax concerns. The imputed interest is considered income to your mother, even though she’s not receiving cash (because she’s forgiving the interest payments to you). This would increase her income tax.

You may want to consider waiting a couple of years to purchase a house and saving the money that your mother intends on gifting you each year until you have enough money to purchase they house you want without these other issues.

Best wishes,

Gina

Jeremy asks:My financial planner told me that I can make withdrawals from my 403(b) account at any time without early withdrawal penalties or federal income tax consequences because I obtained this particular 403(b) account as the result of a Qualified Domestic Relations Order (QDRO). Then as I was leaving his office he handed me a pamphlet that states that I cannot rely on any tax advice he provides. Did he give me correct tax advice? Jeremy

My response:  Hello Jeremy, thanks for visiting.

It sounds to me like your financial planner was confused by the fact that your ex was not taxed and did not have to pay a penalty because of the transfer under the QDRO. Now that it’s your retirement account it behaves exactly like an account you had funded on your own. You can read more about this in IRS Pub 575.

Best wishes,

Gina

Adam asks: I bought a new home last year and moved into it. My previous home, which I owned for over 10 years, is for sale but I don’t expect to sell it very soon. How should I treat the expenses on my previous home? Do I have to treat it as a second home or can I treat it as investment property and then deduct all my utilities, association fees, insurance and depreciation? Is it worth it to treat it as investment property or does the depreciation recapture make it not worthwhile? Thank you, Adam

My response:I’m sorry to have to tell you that you are not allowed to deduct your expenses or depreciate investment property, unless you have placed the property in service as a rental.

I wouldn’t recommend renting your previous home if you believe your home will sell relatively soon, since as of right now you will still qualify for a $250,000 gain exclusion. Thus, if you believe your home will sell, then it would be treated as a second home and you will be able to deduct, as an itemized deduction, subject to limitations, property taxes and interest.

If you believe it will take you several years to sell your home you should investigate the possibility of converting it to a rental.

Best wishes,

Gina