Archive for January, 2014|Monthly archive page

SIMPLE IRA Salary Deferrals Due Jan. 30 for Self-Employed

Originally published in the Cedar Street Times

January 24, 2014

One commonly used retirement plan by small business owners is a SIMPLE IRA plan.  SIMPLE IRA is simply an acronym for “Savings Incentive Match Plan for Employees Individual Retirement Account.”  The plan is, well, fairly simple to set up and operate as well.  You simply fill out the simple SIMPLE form by October 1 and find a custodian such as Vanguard, Schwab, Fidelity, or others to handle the money and you are in business.

There are generally no costs or nominal costs to setup and operate the plan, depending on the custodian and amounts invested, and there are no required annual plan filings with the government.  This has made them appealing for many small companies with employees compared to a 401(k).  For 2013, participants can defer up to $12,000 of their earned wages plus another $2,500 catch-up contribution if over age 50.

The employer also agrees to make a three percent maximum matching contribution.  For example, if the employee defers nothing into the plan from his or her salary, then the employer has no match requirement.  If the employee defers two percent, the employer has to contribute two percent.  If the employee defers three percent, then the employer has to match three percent.  If the employee defers more than three percent, the employer still only has to contribute three percent. (The employer also has the option to select a two percent nonelective contribution in lieu of the three percent match.  This means the employer contributes two percent whether or not the employees contribute anything.)

The employer match portion is in addition to the $12,000 salary deferral and possible $2,500 catch-up contribution.  The three percent match also has a salary cap of $255,000.  So the maximum employer match is $7,650.  I know what most of you are thinking right now…”Gee, that means I will only get a match on the first third of my salary. What a rotten deal!”  Ha!  If you have one of those jobs paying over $750,000 a year, your company is in the wrong plan!

The employer has to remit the employee’s salary deferral portion to the SIMPLE custodian as soon as reasonably can be done, but  in any case no later than thirty days after the end of the month in which the employee’s paycheck was dated.  If the deferral is sent to the custodian within seven days of the paycheck date, it is a safe harbor and will always be considered timely deposited.  The employer match portion, however, can be paid as late as the tax return due date for the employer, including extensions.

So how does it work with the business owner and his or her deferrals?  What about the match?  If the business is setup as an entity such as a corporation and the owner receives a paycheck like any other employee, then the same rules apply that apply to the other employees.

If the owner is self-employed however, such as a sole proprietorship, the net earning for the entire year are considered earned/paid on the last day of the year, and the owner must remit the salary deferral portion to the custodian by January 30th (30 days after month end) of the following year.  So 2013 salary deferrals for a self-employed individual are due in six days.  (This includes the $12,000 plus the $2,500 catch-up if applicable.)

The three percent match is not due until the tax return due date for the owner (generally April 15), including any extensions filed (generally October 15).  The employer match of three percent for the owner is calculated based on the amount of Schedule SE, section A, line 4, or Section B, line 6, before subtracting any contributions to the plan for the owner.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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Do you Run a Business…or a Hobby?

Originally published in the Cedar Street Times

January 10, 2014

I remember a number of years ago preparing a tax return for a woman who was employed part-time, but who also had a side business as an artist – a painter as I recall.  When I was preparing her Schedule C for the art business there were lots of expenses – art supplies and tools, framing expenses, office expenses, vehicle expenses, postage, dues and subscriptions, a home office deduction, meal and entertainment expenses, and lots of travel expenses.  In all it came to over $35,000.  When I got to the revenue side, however, only $400 was listed.  I thought it was a mistake – maybe missing a few zeroes on the end, so I gave her a call.  She said she just had a bad year and sold hardly anything.  “Okay,” I thought, “that is a pretty bad year. I wonder what a good year looks like for her?”

As the story unraveled, there was a history of growing expenses from $10,000 to $35,000 a year and a history of revenues in bad years of $0 to a few thousand dollars in the “good years.”   I could clearly see now what was going on – she must have had about the same natural talent for painting as me and her paintings were so ugly that they wouldn’t be hung in a dumpster, much less purchased.  Actually, that is not what I thought.  I believe she had a hobby as an artist, she loved to travel, and she developed an addiction for tax deductions when she married her art and travel on a Schedule C tax form!

The IRS is very much aware of this phenomenon, and section 183 of the Internal Revenue Code and its related regulations deal specifically with this area.  The rules are known affectionately as “hobby loss rules.”  The basic rule is that if you are not truly engaged in an activity for profit, then your deductions will be limited to your revenue.  This takes all the fun out filing a Schedule C in situations like this, since losses generated are disallowed and cannot offset other income on your tax returns.  If you get audited on the issue and lose, the IRS can go back and disallow the losses from past years, and then assess the tax you should have owed along with stiff penalties and interest that accrue dating back to the dates you should have paid the tax originally.  This can get very ugly.

So how can you safely assume you are engaged in an activity for profit?  Section 183 plainly tells us that if you are profitable in three out of every five consecutive years (two of seven for horse breeding), you are generally presumed to be engaged in an activity for profit.  Of course, if you have a pattern of reporting $200 of income for three years and then $100,000 of losses for the next two, they will not be that graceful towards you.

The meat of their determinations lie in a list of nine characteristics (albeit non-exhaustive) which they apply to your facts and circumstances.  The nine factors are: 1) are you carrying on the business in a business-like manner – records, formalities, changing tactics that don’t work, 2) do you have or did you hire necessary expertise – not only in your subject matter, but in running a successful business, 3) what percentage of your time is devoted to the business (more important with activities that do not have substantial personal or recreational aspects), 4) reasonable expectation that the assets may appreciate in value and offset the expenses, 5) the history of success in similar or dissimilar activities, 6) the history of the activity’s income and losses, 7) if you have occasional profits, how substantial are they, 8) do you have other sources of income, and is this activity providing tax benefits, and 9) how much personal or recreational pleasure is involved in the activity.

People in the arts have a higher level of scrutiny due to the common personal and recreational pleasure often involved.  In a 1977 court case (Churchman v. Commissioner) the court said, “[A] history of losses is less persuasive in the art field than it might be in other fields.”  They also concluded that music falls in their definition of arts.

As you are preparing for your tax returns this year, and if you know you have a business with a pattern of losses, you may want to examine yourself in light of these nine factors.  Keep in mind, however, that even if you lose money for a long time, as long as you can demonstrate over these characteristics, you can still be okay.  Oh, and regarding the client I worked with years ago – once I did a calculation and showed her the potential penalties and back taxes she could owe, she completely dropped the Schedule C altogether.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.