Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for December 1st, 2005

Posted by taxguru on December 1, 2005

Media Myths: The Housing Bubble is Bursting  –  The media love gloom and doom stories of suffering and have been pushing this myth for a long time now.

 

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Posted by taxguru on December 1, 2005

Auditor: Volunteers make errors on taxes – While I got my start in tax preparation with the IRS’s VITA program back in 1975, I would be the first to admit that you get what you pay for.

 

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Incorporating

Posted by taxguru on December 1, 2005

Q:

Subject: Subchapter S Corp vs Sole Proprietorship

Hello,

I read information on your website showing the advantages/disadvantages between C and S Corporations. But I could not find any literature from you on S Corps vs Sole Proprietorships. I have been looking to go from a Sole Proprietorship  (Sched C) to Incorporating and Filing for Subchapter S status.  The reason I am contemplating this is that I was told I can avoid paying social security and medicare taxes on my income.  I know the shareholders of a C Corporation can take dividend distributions. Is this true of S Corporations?  And is this the means to avoid paying ss and medicare taxes.

I would appreciate your input.

Thanks.

A:

Using a corporate structure instead of sole proprietorship is one of the easiest ways to drastically reduce your tax burden, as well as give you additional personal liability protection.  I discuss many of these points on my main website, as well as  in several blog postings.

Before you do anything, you should work with a professional tax advisor who understands how small corporations work, to see how your particular circumstances can most efficiently utilize a C or S corporation.

To save time and money with the tax pro, it would be a good idea to get a copy of one of the basic books on incorporating to familiarize yourself with the fundamentals of how corporations work.  Two of the best are from:

          Nolo Press – printed book    

          Corporate Publishing – free online virtual book

Good luck.

Kerry Kerstetter
 

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Placed In Service

Posted by taxguru on December 1, 2005

Q:

Subject: Section 179 and taking delivery

Hi Mr. Ketstetter;
 
I am looking to buy a qualifying peice of equipment per Section 179 and I was told it may not get delivered (and put into service) until 1/2006.   Can I still take the 179 deduction in 2005 if I only purchase the equipment and not take delivery?
 
Thanks.

 

A:

No, you may not claim the Section 179 or any depreciation expense on your 2005 tax return for an asset that is not placed into service in 2005.  The law is very explicit on this point.

You really should be working with a tax pro who can help you with basic issues such as this.

Kerry Kerstetter

 

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Reduced Social Security Benefits

Posted by taxguru on December 1, 2005

Q:

Subject: Social Security early-retirement rip-off? + C-CPI-U: Escher staircase?

Approaching 62 years old, I have discovered that – should I take the early, reduced Social Security retirement benefit – and then go on working normal hours — my benefits may be reduced to zero until my full retirement date — thought I will be locked into the reduced benefit for life. 

Before your full retirement year, Social Security reduces benefits $1 for every $2 earned above $12,000 a year.  For the tax year in which you retire the formula changes to $1 out of $3 above $31,800 until you reach the magic month.  [http://www.ssa.gov/pubs/10069.html#howmuch]

 

Most people opt to begin benefits at 62.  I wonder how many are blind sided by this upside-down reduction?  Social Security should at least make this benefits sink hole extremely clear to would be early retirees (perhaps even getting them to sign a form stating they understand before jumping in)?

 

If the majority of the citizenry were informed of this Pearl Harbor short-change, change would be forced overnight.  The motivation to discourage work – or whatever the intention – is a miniscule social goal next to the need to provide our elders (hey; that’s me!) with sufficient money to survive. 

 

At the very least, early-retirement benefits lost in one year should upgrade benefits later.  In the age of computers this would entail almost no administrative effort at all.

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The new inflation measure that Bush’s BLS is trying to foist (C-CPI-U; the extra “C” stands for “chained”) to reduce Social Security cost-of-living adjustments takes into account consumer substitutions when the prices of one commodity rise faster than another’s.

 

Depending on how computed, C-CPI-U may be an Escher staircase.  For instance, inflation will be lower if we substitute chicken for pork if the price of pork goes up faster this year – but, what happens when we switch back for the same reason next year: does C-CPI-U reflect the CONTINUING price of chicken or just the current year’s change (the latter practice sounds like some formulas labeled “chained”)?

 

If C-CPI-U is not an Escher staircase, then C-CPI-U may not result in much more than one-time – even temporary reductions — in the inflation rate and benefits  (doesn’t sound like a Republican style set-up to me – better watch out!).

 A:

I understand your disgust with the benefit reduction scheme used for SS recipients under a certain age.  However, this is not in any way a new development and should not have been a surprise to you.  It has been the policy for as long as I have been in the tax business.  In fact, it used to apply to all ages.  Over the years, the penalty on excess earned income had no maximum age applicability.  It was later changed so as to only apply to recipients under 70, and then a few years back was changed again to only apply to those under 65.  It now applies to anyone under the age of eligibility for full benefits, which is 65 and four months for those starting to draw benefits in 2005.  This will be increasing every year, as the SSA continues to raise the retirement age and hope that more people pass away before starting to claim any benefits. 

Depending on how you earn your income, avoiding this penalty may or may not be an easy task.  The earnings limit only applies to compensation for services, most often in the form of W-2 gross wages and 1099-MISC non-employee compensation (NEC) as reported after expenses on Schedule C.

A common strategy to avoid this limit is to change your income from “earned” to “unearned.”  Examples of unearned income include payments reported on Schedule E (rents and royalties) and Schedule B (interest and dividends).  If you own your own business, it’s a simple task to set up a corporation and use it to convert earned income into unearned.  I actually learned this technique from one of the first CPAs I worked for, back in the 1970s.  He was in his 60s and had his accounting practice incorporated so that it could pay him rents instead of professional fees.  He was thus able to continue receiving full SS benefits because the rents weren’t counted against his earned income limit.  That loophole is still available today.

If you work for someone else, you will need to negotiate ways to convert salary to other kinds of income, such as leases or royalties or even 1099 NEC that you can run through a corporation.  A competent tax professional who understands how this strategy works can help you properly arrange things.

Expecting our rulers in DC to remove this unfair penalty is almost hopeless.  The financial “solvency” of the SS system depends heavily on people not being able to draw out all of the benefits they have paid in.  Not having a penalty for opting to receive early benefits would go completely against this requirement that as many people as possible die before recouping their payments in and thus forfeit them to the system. 

It is the case that I normally advise clients to choose the earliest pay-out from SS; but that is always partnered with a strategy to avoid hitting the limit on earned income and being subject to the benefit reduction penalty. 

  
I have to admit that I haven’t studied the new CPI formula.  However, your description of it does fit the standard MO of our rulers; to fiddle with formulas to give the false impression of improving accuracy, while actually just sweeping the real problem under the rug.  It is how our rulers, who have no regard for any time beyond the next election, prefer to pull the wool over our eyes rather than actually do anything bold to tackle the underlying problem.

Thanks for writing and sharing your thoughts.

Kerry Kerstetter

 Follow-Up:

Thanks much for the helpful tax info.
 
I should have included: I wonder what C-CPI-U’s take is when you switch from gassing up the SUV to taking the subway or to less pork and more rice?  On the flip side, C-CPI-U wants to fully assess the performance improvement my modern Timex makes over an ancient Rolex.  C-CPI-U seems to want to include as much value change or exclude as much as needed to lower the inflation rate!  🙂
 
Thanks again.
 

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