Personalized tax answers for iwillteachyoutoberich readers — Part 2

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There is a ton of stuff in David’s tax answers today. He answers the nitty-gritty, telling you exactly what to do, but he also gives valuable high-level advice. He writes, “‘Are you ready to be rich’” means that you have to take fiscal responsibly for your actions – not just work all year and then have someone do your taxes at the end of the year – when you are simply reacting to your situation rather than determining it.”

See Part 1 here.

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Taking Responsibility for Building your Wealth
Post 2 of 3 by David Bergstein, CPA

Are you ready to be rich? In the last post we discussed how paying taxes is a fact of life. Along with paying taxes comes the responsibility to regard almost every decision you make as relating to taxes.

The question of should I be self employed or should I be an employee has taxing implications. If you are self employed you are responsible for both halves of your FICA taxes not just the employee portion. If you accept a job offer because it pays more but does not include fringe benefits such as health insurance or retirement benefits, it may not be the wisest choice. You have the ability to deduct business expenses if self employed but not personal expenses, even though novices often believe that they can write off almost anything.

Whether self employed or an employee, if your goal is to accumulate wealth and prosperity, you must have a plan, specifically, a financial plan of what you are going to do to reach your goals. The choices you make allow you pay more or less in taxes. The general guidance is to defer recognizing income if you can and it is appropriate, and to accelerate expenses that reduce taxes. Everyone’s situation is different, but a good example of this: Joe buys land for investment purposes for $20,000 and its market value increases to $100,000. Should he sell it or should he exchange it? There is something called a 1031 exchange which allows him to defer recognizing the gain on this transaction. This is where I could go into detail on the pros and cons of both or I can ask you to become financially literate yourself by starting to seek out information about tax savings ideas. Another, even more common question is: Should I put money in to a CD and earn x% interest or should I put money into a tax-exempt investment where the principal accumulates tax free? There are reasons to do both.

“Are you ready to be rich” means that you have to take fiscal responsibly for your actions – not just work all year and then have someone do your taxes at the end of the year – when you are simply reacting to your situation rather than determining it . Build a plan, work the plan, save regularly and think taxes. People who accumulate wealth think and work on it every day.

Question 6. I own my own small business and work from an office in my home. Is it better to have my company pay me rent, or to take a home office deduction? Posted by Courtney at March 14th, 2007 at 4:08 pm
Answer. This is an interesting question and the answer is dependent on a number of things. If your business is a sole proprietorship you must file a Schedule C which is a part of your 1040. So if you pay yourself rent, which goes on your Schedule E and also a part of your 1040, you really don’t accomplish anything except maybe reducing your self-employment tax. The answers change as you put together a financial plan of where you want to be (as stated in the beginning of this column above). For example, if you want to write off rent and other expenses, it may be wise to incorporate your business and then pay yourself rent, which means rent is deducted from your corporate return and then picked up on your personal tax return. The only way for a CPA to give you the best advice is to sit down with him or her and detail your situation. The earlier in the year you do this, the better as it allows you to take full advantage of any tax savings strategies you decide upon.

Question 11. I run a small online business and I’d love to find out more about the kinds of deductions that I can make and any other ways of running or structuring my business to reduce the tax burden. Since I am self-employed I end up paying 7% more on my taxes than those that have a regular job. Are there any real tax advantages for a business?
Answer. There are real advantages to having a business and the legitimate deductions that go with it. In many instances you can establish a 401k plan and shelter your income. In some cases individuals travel for both business and pleasure and write off the entire airfare for business if the trip is primarily for business and not overseas. Different rules apply to overseas travel vs. domestic travel. These are just a few things to think about but it’s generally advisable for entrepreneurs to speak to a CPA or at the very least read books on how various types of income are reported and what types of expenses are deductible against your income. A good suggestion is to look at a tax guide on the web such as: http://www.completetax.com/taxguide/text/c60s15d165.asp).

Question 14. I’ve never payed taxes before and got a job this year as a consultant at a software engineering services company. Since I am not technically an employee, and am a consultant, I know my tax burden is higher. Is there anything I can do to lessen this?
Answer. This is another one of those questions that says you should research whether to be paid as a consultant or become an employee. A number of corporations are hiring independent contractors (consultants) to keep their costs down. If you are not an employee then you do have the added cost of paying both halves of your social security contributions, commonly called FICA. A self-employed individual, however, can deduct many business expenses that an employee would not be able to. For example, you might be able to deduct the health insurance you pay directly from your income rather than as an itemized deduction where you can only deduct an amount in excess of 7.5% of your adjusted gross income. Most likely you also will have an automobile expense deduction for mileage or depreciation and other items that are called “ordinary and necessary expenses paid and incurred in carrying out your trade or business” such as supplies, telephone, etc.

Question 32. How do I make an offer of a settlement on taxes I owe to the IRS? What are the requirements?
Answer. This is a very good question that can be answered by sending you to the IRS website at http://www.irs.gov/businesses/small/article/0,,id=104593,00.html which explains what an offer in compromise is and whether this is the best way for taxpayers to resolve their tax debt. I’d also suggest that you seek the advice of a CPA. While many individuals are adept at preparing their taxes themselves, if you’ve not been paying your taxes, trying to sort through this without an advocate may be extremely difficult, and may leave you with a settlement that is higher than it would be with representation.

Question 38. My question has to do with taxes for next year. I am expecting a return of about 1,000 dollars, and currently am claiming “1″ on my withholdings. Should I change my withholdings for next year? Is this a worthwhile change?
Answer. Raising this question is a good example of you taking control of your taxes – and keeping your money with you, where it belongs. If you are getting $1,000 back, that means that you essentially gave the IRS an interest-free loan over the year. Personally, I would rather have my money during the year than wait for a check at the end of the year. To determine how much you should change your withholding, you can go to http://www.completetax.com/calc.asp and find a number of free calculators that will help you. Once you’ve made the adjustment, I would suggest that you take the extra money that you will be receiving in each paycheck and invest it in something that will earn you a return on your investment or place it in a retirement fund for the future.

Question 50. I finished school in May and am now self employed as a contractor. My income stems from a 1099, and I’m told that I probably have to file quarterly. However, I’ve also heard that I can somehow save money by not filing quarterly, and just paying the penalty every year. Is that true, and under what circumstances?
Answer. I would advise you to pay the estimated taxes on a quarterly basis rather than pay penalties. It doesn’t make sense to ever pay a penalty when with proper tax planning you can minimize your tax liabilities.

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  1. [...] posted Part 2 of Personalized tax answers. There are some great detailed questions there. Also, check out Part 1 if you missed [...]

  2. I have a small house that I am fixing up as a rental. I bought it last year using a HELOC on my home, plus a new mortgage.

    My questions are:

    1) Can I add the HELOC mortgage to the basis of my rental property for a Schedule E next year? If not is there another way to carry forward the HELOC interest. (I don’t need the home mortgage deduction this year.)

    2) I have some Gen & Admin expenses related to investing in real estate, but no income yet. Is there a way to report them – this year or in the future – so that I can use them to offset the rental income? (Again, I don’t need the deduction this year.)

  3. I recently received some family heirlooms from an aunt that passed away and have decided to donate them. Can I deduct the fair market value of the items as non-cash charity? The forms always ask for a purchase price or something similar which would be nothing to me.