Category: Tax

Tax Treatment of LLCs

One of the biggest misconceptions of individuals who register their businesses as LLCs with the state is that they’ll now be able to “pay themselves” from their business earnings.

It’s necessary to clarify how LLCs actually work, so that individuals can make the right decisions for themselves and their businesses.

An LLC is a legal entity bound by the laws of the state it was registered in. An LLC is not by default a corporation for tax purposes. If you are the sole owner and member of your LLC you’re considered a disregarded entity by the IRS. This means that for income tax purposes you’re still considered a sole proprietor, and will still have to file a Schedule C. The only time you’re considered a corporation is when you hire employees, in which case you’ll need to apply for an EIN in order to file employer tax returns such as Form 941.

You are not obligated to remain a disregarded entity, however. The IRS offers business owners the option to become either a C corporation or an S corporation (each with their own specific tax rules and consequences).

In short, an LLC does not offer by default favorable tax treatment to sole proprietors, unless they change their classification to a C corporation or S corporation. LLCs do offer business owners some legal protection to their assets and might still be a good business option. It’s important to discuss this topic with both a lawyer and a tax professional if you’re thinking of going this route.

For more information check out IRS Publication 3402, Taxation of Limited Liability Companies.

Tax Rules for Students Working

Scenario: An 18-year-old college student, who is claimed as a dependent on his parents’ tax return, decides to get a job. He wants to know how this will affect his parents’ return. 

There are three main concerns when a student takes up a job while being claimed on his parents’ tax return.

#1. Can my parents still claim me?

Your parents can still claim you even if you get a job, so long as you’re still under the age of 24 at the end of the year, remain a student, and you don’t provide over half of your support. Technically, you’re supposed to live with your parents, unless the only reason you’re not is because you’re going to school.

#2. Do you have to file a tax return?

Maybe. As a dependent, there are certain filing requirements you must meet to be required to file.

If your income comes solely from a W2 job and you haven’t married, you must have made over $12,550 (for the 2022 tax year). If you made less than this, you might still want to file if a refund is in order. Which leads us to our third concern.

#3. If I file, will I owe?

How much you’ll get back or owe boils down to your standard deduction. As a dependent, your standard deduction is the larger of $1,100 or the income you earned plus $350 (but not more than $12,550).

For example, you got a summer job and made $5,600. Your standard deduction is the larger of $1,100 or $5,600 plus $350. Your standard deduction is $5,950. On a straight-forward return like this, taxable income is 0 and there’s very likely a refund.

Note: It’s important for you and your parents to be on the same page. The best course of action is to consult a tax professional before getting a job to have a higher degree of certainty of what to expect come tax time.

Deducting Mortgage Interest on a Duplex Rental

If you purchased a duplex so that you can live in one unit and rent out the other, you’ll have to calculate how much of the mortgage interest belongs to the rental unit, and how much to the personal unit.

When it comes to any property that is used for both personal and rental purposes, the IRS allows for any “reasonable” method of calculation. For single family properties, you can either divide the number of rooms being rented by the total number of rooms in the house, or you can divide the square footage rented by the total square footage of the property.

For duplexes, the calculation boils down to the size of the units. If both personal and rental units are of similar size, it’s reasonable to split the mortgage interest and real estate taxes in half. If there is a considerable difference in size, perhaps the square footage method might work best. Mortgage interest allocated to the rental unit can be deducted on Schedule E, line 12. Mortgage interest belonging to the unit used for personal use can be deducted on Schedule A, line 8a. (“Should You Save Your Receipts” offers more information on itemized deductions.)

Are Social Security Benefits Taxable?

If your only income comes from social security benefits, generally there’s nothing to report and your benefits are not taxable.

If, however, you have additional income such as wages, pensions, capital gains, dividends, and interest, you will have to figure out how much is taxable, if any.

To figure out if any of your benefits are taxable you take 1/2 of your benefits and add it to your additional income. If you’re married and file jointly, you’ll have to combine both incomes. If you’re married and file jointly and your spouse isn’t receiving benefits yet, you’ll still have to combine incomes. If your income is more than your “base amount”, some of your benefits might be taxable.

Base amounts are based on filing status. For 2022 the base amounts were:

Single, head of household, and qualifying surviving spouse have a base amount of $25,000.

Married filing jointly has a base amount of $32,000.

Married filing separately (and lived apart from your spouse) has a base amount of $25,000.

Married filing separately (and lived with spouse) has a base amount of $0.

It’s important to note that even if your benefits are not taxable because you did not go over your base amount, you might still need to file a tax return to report your additional income. To find out how much of your benefits are taxable, if any, you’ll have to fill out Worksheet 1, found in the most current Publication 915 of the IRS.

If part of your benefits is taxable, and you anticipate this to be the case for future years, it’s important to prepare for a tax increase. One way to handle a higher tax is to have tax withheld from your benefits. You’ll need to submit Form W-4V with the Social Security Administration. Another option is to increase withholding on your other sources of income.

Should You Save Your Receipts?

Deductions lower your taxable income. The lower your taxable income the lower your tax. The IRS gives you two options to lower your tax. The standard deduction or itemized deductions.

By default, each filing status is given a set amount to deduct. For 2023 those amounts were:

The standard deduction increases each year to adjust for inflation. There is no need to save receipts if you’re using this option.

The second option is to itemize deductions. This option might be beneficial for taxpayer who have qualifying deductions that add up to an amount higher than the standard deduction. In this case, saving receipts is a must.

Qualifying itemized deductions fall under the following categories:

Medical/dental expenses

State and local income taxes

State and local property taxes

Mortgage interest

Charitable contributions

(Visit the IRS for an extensive list of itemized deductions.)

Saving receipts might not be necessary if you think the standard deduction is as much as you’ll qualify for. In many cases, the standard deduction might be higher than all your qualifying itemized deductions tallied up. But even if you don’t need to save receipts, consider keeping track of your expenses for budgeting purposes.

Form W9 For Independent Contractors

If you’re planning on doing freelance work for a business, either a company or another independent contractor, they might have you fill out Form W9. This is typically the case if they’re expecting to pay you over $600.

The reason they have you fill this form out is because they’ll need your name and TIN (ssn or itin) for them to report your earnings to the IRS. This way, they can deduct what they paid you and have written evidence of that deduction. They send Form 1099-NEC (formerly 1099-MISC), to you and the IRS.

Filling out the form is very straightforward.

Line 1: Your name as it’s registered at the Social Security Administration.

Line 2: If you’ve registered your business under a fictitious business name, that name will go here. If you don’t have a FBN leave it blank.

Line 3: If you’ve never incorporated your business and have not applied for a corporate tax classification, check “Individual/sole proprietor”.

Line 4: Leave this section blank if you’re a sole proprietor (same as independent contractor) since you don’t qualify for any exemption to backup withholding (more on this later).

Line 5-6: Your address. This can be your home address if you operate from home, or your business address if you have an office.

Line 7: You can leave this blank.

Part I: If you have either a social security number or ITIN, write that down here. If you operate under an Employer Identification Number, you can write that instead.

Part II: Read certification, then sign and date if you comply.

Will they take taxes out of your checks?

They shouldn’t. Unlike a W2 job, the business giving you work is not responsible for submitting your taxes to the IRS. You’re solely responsible for paying your own tax.

Check out this post for more information on making estimated tax payments.

There is the matter of “backup withholding”, but this doesn’t apply to independent contractors unless they failed to provide their correct name or TIN.

U.S. SAVINGS BOND INTEREST

Series EE and Series I bonds are a considerably safe way to start investing. When you purchase a U.S. Savings Bond, you’re lending money to the U.S. government and the government becomes obligated to pay you back plus interest.

The IRS allows taxpayers two ways to report the interest. You can either report all the interest at once the year you cash in your bond, or you can report the interest every year. If you purchase both Series EE and Series I bonds, the method you use to report interest for one will apply to both types of bonds. You’re allowed to start paying interest every year if you had initially opted for paying all at once the year your bond is cashed. You’ll need permission from the IRS, however, if you wish to switch from paying interest every year to paying it all at once.

Typically, the person who purchases the bond is the person who must report and pay tax on interest earned. This is so even if the bond is registered to co-owners. If both co-owners purchased the bond, then interest is taxable to both owners. In cases when a bond is purchased for a child and is registered only in the name of the child, then interest is taxable to the child.

For those who choose to report interest the year of redemption, you’ll receive Form 1099-INT if interest is more than $10. Those who choose to report interest each year will also receive Form 1099-INT, however, an adjustment might have to be made on the return if paper bonds were purchased. This is because the Treasury method for processing paper bonds is not as efficient as it is for electronic bonds.

Adjustments are made on Schedule B. The following example shows how to make such an adjustment.

For more information on Series EE and Series I bonds, visit the Treasury Direct site.

The Tax Factor In Cash Value Life Insurance

Cash value life insurance is a type of permanent life insurance. It provides death benefits, as well as a savings feature. Each premium gets split into policy coverage and investment. It is this investment portion that provides the life insurance with its cash value.

Much of the interest in cash value life insurance originates in retirement planning. If it will provide sufficient supplemental income is something that a financial advisor and a policy agent can discuss.

Cash value life insurance grows tax-deferred. So, the interest it accumulates does not get taxed during the lifetime of the policy. Interest is only taxable when it is withdrawn. There are two ways to keep withdrawals tax-free.

One way is to withdraw amounts only from deposits made towards the premiums (or your cash basis), and not those made towards the cash value. This is considered a return on principle, and it is not considered income.

A second way is to withdraw in the form of a loan. A loan will not be taxable; however, you will owe the loan plus interest to the insurance company.

Caution: it is possible to go over with withdraws from your account and end up withdrawing from the cash value. The danger of this is that you may end up lapsing the policy. If this happens, and you happened to have accumulated a substantial cash value, interest will become taxable in the year you withdraw it. Cash value life insurance offers the option to surrender the policy. This is essentially a total distribution of the policy (minus any surrender fees the company charges). If proceeds were more than your cash basis, proceeds will be reported on Form 1099-R.

It’s important to note that cash value is only available on permanent life insurance, not term life insurance. Cash value life insurance premiums are higher than on term policies, along with policy and surrender fees. It’s important to be prepared with a list of questions when speaking with both an advisor and an insurance agent in order to avoid costly surprises down the road.

What To Know About Deducting Business Miles

If you’ve started a business (or side gig), and use your car, you may be able to deduct the miles driven. If you use your car for both business and non-business purposes, you can only deduct the miles driven for business purposes.

Business miles are considered miles driven from your main place of business to other work locations. For example, if you rent an office and have to visit a client, you’re allowed to deduct the miles driven from your office to your client and back to your office. Miles driven from your home to your office are not deductible. These are considered commuting miles.

If you operate your business from your home, however, and visit clients, you’re allowed to deduct miles driven from your home to your clients.

You’re allowed to deduct business miles (also called the Standard Mileage Rate) if you choose this method the first year your car is available for business use. Meaning that you must use this method the first year you claim your car on your tax return.

You must also own or lease your car in order to use the SMR.

The following situations disallow the use of business miles:

  • Using 5 or more cars at the same time (as in fleet operations).
  • If you claimed a depreciation deduction for the car using any other method than the straight-line method.
  • If you claimed a Section 179 deduction on the car.
  • If you claimed the special depreciation allowance on the car.

If any of the previous situations apply, you must deduct actual expenses.

The burden of proof is always on the taxpayer, which makes mileage logs extremely important when it comes time to substantiate deductions taken.

A mileage log should include the following:

-Date and time of the business trip.

-Purpose of the trip.

-Miles driven on that trip.

Mileage can be tracked on spreadsheets, notebooks, apps, or any method the taxpayer chooses.