Using Your Nest Egg To Buy a Franchise –  Another look at the BeneTrends concept that I have mentioned many times.

Thomas Sowell looks at how the left persists in distorting the effects of tax rate cuts.

The truth is that they result in overall higher revenue and anyone who says otherwise should not be trusted.

From another CPA:

Subject: Small Business Audit Risk

Here is some interesting data for IRS examination coverage based on returns filed in 2004:

 

Type of Return                                  % covered

Sch C(gross receipts under 25K)           3.68

Sch C(25 to 100K)                                2.21

Sch C(over 100K)                                 3.65

Small Corp(assets under 10M)               0.79

1065                                                    0.33

1120S                                                  0.30

 

It appears that the overall audit risk is much greater for Self-employed versus partnership or corporation filings.  However the data is broken down further.  It turns out that Sch C with gross receipts of less than 100K have only about a 0.5% chance of examination by a Revenue Officer or Tax Compliance Officer.  The balance being Compliance Center inquiries which usually ask for clarification, more data, etc.  In the rest of the filing categories, most of the exams are Revenue or Tax Compliance Officer, meaning a face to face visit.

 

I wonder if the cause of the differences could be that many, many Sch C are completed by the taxpayer whereas most entity returns are prepared by a tax professional.  We will probably never know the real reason as the IRS avidly protects its selection criteria.

My Reply:

While that is a plausible theory to explain the disparity in audit coverage, I had a slightly different one when I saw those stats a few months back.

I think it has a lot to do with the looser internal controls with most small Sch. C businesses than is normal with more formally established business entities, allowing for much greater opportunity for the owners to put money in their pockets. This difference is especially true when there are multiple owners of the business, such as with a partnership. One of the most basic internal controls is the division of duties and the inability of one person to handle all of the money without anyone else checking on him/her.  While it obviously possible for multiple owners to collude to cheat on the business’s taxes, it is much less likely to happen than with a single person operation who has nobody looking over his/her shoulders.

It has also long been known that IRS has had their sights set on businesses that operate mainly with cold hard cash because of the skimming opportunities available and no bank account paper trail for IRS to work with.  While I don’t have any stats on these particular businesses in terms of entity, I’m guessing that more of them are Sch. C because of the lack of formal business requirements.  Somebody who would want to cheat on their taxes by under-reporting income would most likely opt for the lowest profile business structure, which we all know is a Sch. C.

That’s just my theory.

Thanks for writing and sharing yours.

Kerry Kerstetter

Follow-Up:

Yes, internal controls are certainly a problem and I am sure that the IRS recognizes that.  I have also found that problem in family businesses that are organized as partnerships or S corps.  They usually start off paying attention to the details of cash moving through the company but then get sloppy and cash ends up going to non-business purposes.  Most do it from ignorance and I encourage/help them fix it.  I’ve had a few that feel that actual cash is not income and have had to drop them as clients.

 

Thanks for the response. 

 

 

Q:

I have a question. I hope you can answer. I signed a contract to buy a house for primary resident about 2 yrs ago. My settelment is this week for that house and currently i am renting. I am planning to sell that house and buy another one within one year of time. If i sell my house the one i am getting this week. I will have a capital gain and i like to if i were to buy another house will i be paying capital gain tax?

If you can get back to me, i will appreciate it. And what will be your fee.

Thank You,  

A:

I assume you are talking about a home in the USA because that is the only country’s tax laws I am familiar with.

You need to check out the info on home sales on my website plus discuss your potential gain with a professional tax advisor.

Some of the specific issues that you will need to cover with him/her include:

The tax free exclusion of gain is only available based on time that you both own and occupy the home as your primary residence. This means that the past two years do not count. Having an option to buy a home is not the same as actually owning it.

Since you plan to sell it after less than two years of ownership, your gain will be taxable unless the quick sale is due to health, employment. or other unforeseen circumstances. Seeing as you are going into this with the preconceived goal of selling within one year, it may be difficult to support the use of this pro-rated tax free exclusion. It is normally associated with unexpected events that happen after you start owning and residing in the home. Your personal tax pro should be able to better work with you to see if you qualify.

What you do with the sales proceeds is completely irrelevant to the issue of taxable gain. It won’t make one bit of difference whether you buy a new house or not.

If your gain will be taxable, and it’s a large amount, there are a couple of additional things to keep in mind.

If you can close the sale more than 12 months after your purchase date, you will be able to use the long term capital gains tax rates instead of the much higher ordinary income tax rates.

You should protect yourself from being unable to pay the taxes on time by holding back their estimated amount from the cash you put down on the purchase of your new home.

These are just some of the issues you will need to discuss in much greater detail with your own professional tax advisor.

Good luck.

Kerry Kerstetter