House backs bill to end private tax collections – But the Senate doesn’t appear to agree; so this program will most likely continue.  I haven’t had any clients encounter these free-lance bounty hunters; so I would be interested in any real life comments from tax pros or taxpayers who would like to share their experiences. 

Q:

Dear Kerry

Thank you very much for taking the time to send such a thoughtful response.

Is there a tax professional that you might recommend in Austin, Texas?

Many thanks again for taking the time to help with my questions!

Kind regards,

A:

There is a Texas tax pro listed on my website. 

Be sure to check out my hints on choosing a tax pro, especially the point about geographic location not being as important as other criteria.

Good luck.

Kerry Kerstetter

Follow-Up:

Thank you for the kind reply and info, Kerry!

All best

Q:

Hi Kerry,

 

First of all I would like to thank you for the website!  It’s very informative and a great read.  But there is something that recently came up that is driving me crazy.  I hope it’s ok for me asking.

 

I run a dedicated server business which basically means I purchase rackmount servers and then you can say I rent them out to individuals and companies for a monthly fee.  Now the question is regardiing the Section 179 and the actual server purchase.  What the CPA has done is utilized the maximum Section 179 and then depreciated the rest.  Now this provides a huge problem is many ways.  First of all assuming I purchase the server for $1,000 in will take many months to recoup just the initial cost of the server not including the cost to maintain the server, power cost, etc.  Now what is being proposed is that the excess of the maximum in the Section 179 is now considered “income” – taxable “income”.  So now this $1,000 server has become a $1,000 + tax rate server and will take even longer to break even.  What is worse is let’s assume the excess is $200,000, now I just spent that $200,000 to acquire the server to which the customer will go on.  How in the world is it expected of me to have the taxable rate for this $200,000?

 

So in essence we have my payroll / dividend which gets passed down to me as a normal s-corp would.  Let’s assume it’s $100,000 so roughly with state and federal would be $40,000 tax liability.  But now if you pass on the above server purchase above the Section 179 limit then I am supposed to magically find another $80,000 in tax fee??  Taking the above $200,000 which is now “income” at 40% is $80,000.  So we now take the $80K and original $40K income tax which would equal $120K.  Which in the end would mean I have a net of negative $20k!  What in the world is going on here?  I know I am missing something and hoping you can give some insight before I discuss further with CPA.

 

Hope the above makes sense…  Shouldn’t the “servers” which I need just like I need the power / space to house them in be considered a “operating expense” and then none of this non-sense would happen?

 

Thanks for your time!

A:

I’m not sure if I’m completely clear on your question.  It seems to be that you are upset at not being able to fully deduct the cost of all of your new equipment in the very first year. 

From a purely cash basis of running a business, that is a valid concern, especially if you pay cash for all of the new items rather than finance them with loans.  That is simply a reality of running a business and something that you are going to have to learn how to deal with.

From the perspective of GAAP (generally accepted accounting principles) as well as tax law, unlimited first year expensing is not how new equipment has ever been treated on the books of businesses.  There is obviously a big difference between the treatment and deductibility of operating supplies that are used up in less than one year, and items that last for several years.  It has always been standard accounting practice to amortize or depreciate the cost of assets that provide service to the business over multiple years over those years as a better matching of expenses with the related revenues.  This has always been the case for all kinds of businesses that buy equipment.  Trucking companies and machine shops have the exact same situation that you have.

If your servers are used over more than one year, you will have to deal with this as a depreciation issue.  If you have a track record of having to replace each of your servers in less than one year, you could possibly justify deducting their purchases as annual operating supplies.  If you try this approach, you need to be very prepared to document the fact that none of your servers last over a year because the large numbers involved will most definitely attract IRS scrutiny.  An experienced tax pro will know how to include the proper documentation with your tax return to prevent an IRS audit on this issue.

In order to encourage business owners to stick their necks out and acquire more equipment, there have been various tax incentives passed by our rulers in DC over the year.  The most lucrative have been the Investment Tax Credit, which gave a rebate of 10% of the purchase price right against the taxes (repealed in the 1986 tax law) and the Section 179 expensing election, which has been raised from its earlier limit of $5,000 per year to the $128,000 we will have for 2008.  The tax savings from the Section 179 deduction are designed to offset the kind of cash flow problem you alluded to in your email.

What you need to do is to work more closely with your professional tax advisor to ensure that you don’t put yourself into a cash flow problem.  This may entail financing some of the equipment purchases with loans in order to be able to retain some cash for other expenses, including taxes.  Another strategy may be to stagger your equipment purchases so that you can maximize the annual Section 179 allowance.  Buying too much in one single tax year can very easily cost you much more in taxes than you would have if you spread those purchases out over multiple years.

I hope I addressed your concerns.  If I missed the point, please let me know.

Kerry Kerstetter

Follow-Up:

Kerry,

 

Thank you for the detailed explanation and you hit it on the money.  I simply was not aware that the equipment expense will be considered income when it reaches over a certain amount.  Everything was paid cash so now I have to pay taxes on it, which IMO is extremely unfair.  Simply I have to make purchases smarter and try to get into leases and longer term notes than paying cash.

 

Will be certain to get this in order for 2008 so we don’t encounter this problem ;-).  Know that we are utilizing the section 179 to the max.  Will look into the tax credit as you noted.

 

Thanks again!

My Reply:

I’m glad I was able to help.

The Investment Tax Credit for new equipment purchases is no longer available.  It was repealed in 1986.  I was just explaining the history of tax incentives for new equipment purchases.  The Section 179 expensing election was designed as a replacement for the ITC with the same qualifying rules.

Your personal tax advisor can give you much more details for your unique circumstances.

Good luck.

Kerry

Q:

Subject: questions

Saw your website and have a few questions.  I have gone back to school and have an assignment on the various types of businesses and their associated negative or positive ramifications on each one.  Do you have a second to chat?

A:

I’m sorry, but it has always been my policy to not answer homework questions.

I barely have any time to answer real world questions.

Good luck.

Kerry Kerstetter

Man Pays Big Tax Bill in Coins, $1 Bills – Interesting way to make a statement about taxes.

Q-1:

Subject: early social security

If one takes social security @ 62 and earns more than 12K but puts the excess amount in a defered program like 401K is the earned income still counted as earned income

A-1:

Unfortunately, putting a huge chunk of current W-2 income into a deferred comp plan in order to avoid the SSA’s penalty on those with excess earned income (over $12,960 in 2007) would be too easy.  SSA counts the full amount earned during the year, which is normally going to be the amount subject to MediCare tax, not the smaller amount subject to income tax.

There aren’t as many opportunities for avoiding this penalty by W-2 wage slaves as there are for self employed individuals, who have several very easy methods to accomplish this since SSA looks at the net Schedule C income and not the gross pay, as they do for W-2 recipients.

I hope this answered your question.

Kerry Kerstetter

Q-2:

Sec 125 and flexbenefit plans are not subject to SS so if all the money went into pay for sec 125 benefits would that work?

A-2:

It’s my understanding that SSA doesn’t look at those kinds of benefits as part of their earned income calculations.  So, if they don’t show up in the Medicare Wages box on the W-2, I don’t see how they would be part of the benefit reduction process.

Depending on how much money you are talking about shifting to tax free benefits, you need to be very careful that the amounts are reasonable and in compliance with the kinds of expenditures spelled out in the business’s particular Section 125 benefit program and are not disguised compensation.  In this matter, there is more potentially to fear from IRS attempts to reclassify it as taxable income than from SSA trying to use it to reduce benefits if things are handled properly.

Kerry

Q:

Subject: S CORPS

I was reading your article on S Corps and was wondering if each corporate officer must be a shareholder in the S Corp?  In other words, does the title of corporate officer imply ownership or can it be a status only recognized perhaps in the articles of incorporation or even set up at a later date?  (ie is it possible to be a corporate officer in as S Corp but not receive a K1?)

 Thanks for any input you can forward.

A:

While it is very common with small corporations for one person or a few persons to encompass all of the roles in operating them, that is not required.  Different people can have different roles.

It is really no different than with a large billion dollar corporation, where the roles are usually held by different people.  The most common roles are shareholders, officers, directors and employees.  Although a person can have more than one of those roles, they don’t have to and can just fill one role at a time.

So, with an S corp, just as with a C corp, the shareholders can be different people than the officers or than the directors or than the employees.  The critical difference for S corps is that there are special limits on who can be a shareholder without jeopardizing the S status.  Your personal professional tax advisor can assist you in complying with those restrictions.

Besides consulting with your own personal professional tax advisor before setting up a corp or making any major decisions as to its strategies, you may want to check out the very useful reference materials on the principles of corporations and how to operate them properly from such sources as Nolo Press.   I have been using their books for well over 20 years and still frequently refer to them.  Reading over them will save you a lot of legal fees, as well as keep you out of trouble.

Good luck.  I hope this helps.

Kerry Kerstetter

Q:

Subject: Historical annual tax free gift allowances

Kerry,

What were the annual tax free allowances for gift taxes from 1965 to 2007 by year?

 Example

 2007                                                                                  $ 12,000

2006                                                                                              $ 12,000

2005                                                                                              ?

2004                                                                                              ?

2003                                                                                              ?

 

     1965                                              ?

A:

My policy is to not answer homework questions.  However, check out this post from almost four months ago. 

Kerry Kerstetter

Q:

Subject: c vs. s corp, llc, and other other choices I might have….

Hello,

 

I ran across a page from your webiste on the s corp vs. c corp that was very informative and quite good.  I am knowledgeable in these areas and have been talking to lawyers, accountants, etc… about the best way to structure my businesses…. for tax reasons… but also quite importantly… liability reasons….. and want to set up a structure that would protect my personal assests from the company’s in the event of any lawsuits etc…  The business I am in… and most concerned with is the fitness business(gym ownership).  Questions arise when talking about “piercing” the corporate veil??  Any articles/opinions relating to that….?

 

I intend to look at your websites… blog etc.. in more detail soon.

 

Thanks,

A:

You are correct that maintaining the proper separation between your personal and corporate things is very important in order to protect against piercing the corporate shield by either IRS or overly aggressive attorneys.  Many small corporate owners do jeopardize this protection by commingling their personal and corporate records and assets.  This gives IRS and attorneys a perfect opportunity to ignore the corporate shield and accuse the owners of operating as if the corp is merely an alter ego of themselves.

I’m not an attorney; so I don’t write a lot about this.  I’m sure there are plenty of blogs by attorneys out there that will provide a variety of opinions on this subject.  However, the ultimate decisions as to whether you are conducting yourself properly in this regard should be determined with the assistance of your personal legal counsel, with input from your personal professional tax advisor.

Good luck.

Kerry Kerstetter

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