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Tips on tip reporting

If you are like millions of taxpayers who work in the service industry, you may receive tips. The tax code is clear; if you receive tips you must report them as income. Some employers have systems to make this easy, while others do not. Here are some suggestions:

 

Think 1-2-3

Proper tip reporting has three components.

1. Keeping a daily tip record

2. Reporting your tips to your employer

3. Recording your tips on your income tax return

 

Recording tip activity

Per the IRS, you can keep your tips by either maintaining a tip diary or by saving documents that show your tips. If your employer does not provide you with an electronic form of a tip diary, you can always create your own. The IRS has one for your use in Form 4070A.

 

Reporting tips to an employer

You should record daily activity in your diary and then provide a monthly summary to your employer by the 10th of the following month. The report should include the following elements:

  • Your name and address
  • Your social security number
  • Employer name and address
  • Time period
  • Date submitted to employer
  • Your signature
  • Tip information: cash tips received, credit/debit tips received, tips paid out to fellow workers, and net tips received

 

Paying taxes

With proper tracking and reporting of tip activity to your employer, filing your taxes on this income can be done without too much trouble. Here are some ideas.

Use your employer for reporting. With proper reporting, your employer can help ensure taxes are withheld and sent in for you. This can help you avoid a large tax bill at the end of the year.

Giving your employer funds. If your tips are a high portion of your income, your wages may not be sufficient to cover your taxes. To solve this, you can provide some of your tip income to your employer to pay a proper level of withholdings on your behalf.

 

Other things to note

Service charge or tip? If your employer adds a set tip amount to a bill (18 percent automatic tip for parties of six or more), this is not a tip, it is a service charge and is treated as wages.

Shared tips. Be careful reporting those tips you share with others. Clearly report your own net tip income to your employer. Do not report gross tips that you share with others on your tax return.

Know the penalty. If you do not report tips to your employer, the potential penalty is 50 percent of the social security and Medicare-related taxes you may owe on the unreported tips.

Allocated tips. Sometimes your employer pays you tips and reports them on your W-2 that are above what you reported to your employer. The good news? You receive additional income above your hourly wages. The bad news? You will owe income taxes AND social security and Medicare taxes on these tips.

 

Keeping track of tip income can be made manageable by developing a good reporting system. Please ask for help if you need assistance before it gets out of hand.



Do a business valuation when you’re ready to sell your company

Well before you’re ready to sell your company, you’ll want to determine its fair market value as a starting point for negotiations. Of course, obtaining a reasonably precise value for your business is often a complicated and time-consuming task. Accurate appraisals must weigh a variety of factors and incorporate numerous assumptions. The more precise the underlying numbers and suppositions, the more likely the appraiser’s determination of fair market value will reflect what a willing buyer would actually pay. Here are two questions an appraisal should address.

  • How does your business compare? If you’re operating a service business, your valuation will differ – often substantially – from a company involved in light manufacturing or retail. Buyers will expect a reasonable return on their investment, a return that is often represented as some form of earnings multiplier. For example, your business may be valued at three times projected earnings. Once determined, that number can be compared to businesses of similar size in your market. Of course, accurate valuations must compare apples to apples. “Earnings” must be defined. Should “earnings” include or exclude the owner’s pay, interest expense, depreciation, or taxes? A careful appraisal will also scrutinize the balance sheet. The basis for valuing tangible and intangible assets (including non-compete agreements) and liabilities (such as mortgages, installment loans, and accounts payable) should be clearly laid out – before the business is put on the block.
  • Will present trends continue? The future may be difficult to predict, but a careful analysis should be based on conservative projections, assumptions, and common sense. If, for example, the business is expected to retain skilled management and employees, buyers may be willing to pay a premium. If, on the other hand, the company is overly dependent on a few products or customers, potential buyers may be scared off. Or they may require concessions to mitigate perceived risk. Again, a careful appraisal will consider many such factors and value the business accordingly.

Remember: an appraisal is merely a starting point for negotiations. The more accurate the appraisal, the more likely the business will be priced correctly and potential buyers will be attracted. Unfortunately, determining the fair market value of a business may be fraught with missteps and faulty assumptions. For that reason, hiring a trained and objective professional is often a worthwhile investment.



The rules for withdrawing from a 529 college saving plan

Here’s an overview of three types of 529 plan distributions.

  • Qualified withdrawals. When you take money from the account to pay for college education expenses such as tuition, fees, books, supplies, and equipment, the withdrawals are generally tax- and penalty-free, no matter the age of the account beneficiary.

    Caution: Part of the distribution may be taxable when the account beneficiary receives tax-free assistance such as a scholarship. In addition, you must coordinate 529 withdrawals with the American Opportunity Credit and Lifetime Learning Credit, as well as distributions from Coverdell education savings accounts. These rules prevent the use of the same expenses to obtain multiple tax benefits.

  • Nonqualified withdrawals. The earnings portion of withdrawals that are used for anything other than qualified education expenses are taxable. You’ll also have to pay a 10 percent penalty on the earnings, unless an exception applies.
  • Rollovers. You can deposit or rollover withdrawals into the 529 plan of a family member, or into another account of which you are the beneficiary. When the rollover is completed within 60 days after you take the initial distribution, it’s not taxable.

If you have questions or need help calculating 529 plan withdrawals, please call our office.



Is your HSA a retirement tool? The good, the bad, and the ugly

Health Savings Accounts (HSAs) are a great way to pay for medical expenses, and since unused funds roll over from year to year, the account can also provide a source of retirement funds in addition to other plans like 401(k)s or IRAs.

But be aware HSAs can also come with significant disadvantages and less flexibility when compared to other retirement investment tools.

 

The Good

HSAs work best when they are used for their designed purpose: to pay for qualified medical expenses. Neither your original contributions to an HSA nor your investment earnings are taxed when used this way.

This makes HSA funds valuable, given that medical costs are one of our largest expenses as we age. The Employee Benefit Research Institute estimates the average 65-year-old couple will need $264,000 to pay for medical care over the course of their retirement. Being able to cover that amount with pre-tax dollars greatly extends the value of retirement savings.

In addition, unlike other retirement plans, there is no required distribution of funds after you reach age 70½.

 

The Bad

First, you can only contribute to an HSA if you have a high-deductible health insurance plan. That means you will pay more out of pocket each year when you need to use health services, which could make it difficult to build a balance within your HSA.

Second, contributions are limited. Annual contributions to HSAs are limited to $3,400 a year for individuals and $6,750 a year for families. These limits get bumped up by $1,000 for people aged 55 and older. You also may only contribute to an HSA until your retirement age.

Finally, HSAs typically have fewer investment options compared with other investment tools, including 401(k)s and IRAs. The accounts often have high management and administrative fees. All this makes building HSA earnings tough to do.

 

The Ugly

Before you reach age 65, non-medical withdrawals from HSAs come with a whopping 20 percent penalty, plus they are taxed as income. Even after age 65, both contributions and earnings are taxed when they are withdrawn for non-medical expenses.

In this way, HSAs compare unfavorably with 401(k)s and IRAs, which end their early withdrawal period earlier, at age 59½, and also have lower early withdrawal penalties of just 10 percent.

HSAs are a powerful tool to help manage the ever-rising costs of health care. Knowing the rules and the costs associated with using these funds outside of medical expenses can help you position an HSA with your other retirement options.



Give to cut taxes

If you are in a position to give, making annual gifts can be an excellent strategy for reducing both your estate and income tax liability. Doing your gift-giving during midyear rather than late in the year is especially smart if you are gifting income-producing real estate. By doing so, you may further reduce your 2017 tax liability.



Parents need to do estate planning

For a parent, estate planning is especially important. The first priority is to make sure your children are protected in the event that something happens to you. Your estate plan should appoint guardians for your minor children, as well as provide for their financial well-being.



Don’t pay tax on a home sale

The law lets you sell your home tax-free if you meet certain requirements. The home must have been owned and used as your principal residence for at least two of the five years prior to the sale. Couples can enjoy up to $500,000 of tax-free profits from a home sale, while singles qualify for up to $250,000 of tax-free gain.

To the extent possible, time home sales to meet the requirements in order to enjoy tax-free profits.



September 15 tax deadlines for business

September 15 is an important tax filing deadline for partnerships and corporations. It’s the filing deadline for 2016 tax returns for calendar-year S corporations that received an automatic extension of the March 15 filing deadline. It’s also the filing deadline for 2016 partnership tax returns that received an extension of the April 15 filing deadline. If you need assistance, contact our office.



What if you have a casualty gain?

You may be able to claim a deduction on your current or prior-year federal income tax return for casualty losses from sudden, unexpected, and unusual events, such as tornadoes, hurricanes, and certain straight-line winds.

But what if you have a casualty gain?

Odd as it sounds, when the reimbursement from your insurance company or other payor exceeds your adjusted basis in damaged property, you have an “involuntary conversion gain.” An involuntary conversion is treated as a sale and can result in taxable income. That’s true even when the property is your personal home, assuming the gain is more than your allowable exclusion.

Whether the gain is taxable depends on several factors. For example, you could choose to replace your damaged property with similar property. Making the election allows you to postpone all or part of the tax.

In general, you have two years to replace damaged property, and you may be able to request an extension for an additional year. If your location is declared a federal disaster area, you have up to four years to make the replacement.

Please call for more information about casualty gains and losses. We’ll help you get the most beneficial tax treatment.



Five home office deduction mistakes

If you operate a business out of your home, you may be able to deduct a wide variety of expenses. These may include part of your rent or mortgage costs, insurance, utilities, repairs, maintenance, and cleaning costs related to the space you use.

It can be a tricky area of the tax code that’s full of pitfalls for the unwary. Here are some of the top mistakes people make:

    1. Not taking it. This is probably the biggest mistake those with home offices make. Some believe the deduction is too complicated, while others believe taking a home office deduction increases your chance of being audited. While the rules can be complicated, there are now simple home office deduction methods available to every business.
    2. Not exclusive or regular. The space you use must be used exclusively and regularly for your business.
      • Exclusively: If you use a spare bedroom as a business office, it can’t double as a guest room, a playroom for the kids, or a place to store your hockey gear. Any kind of non-business use can invalidate you for the deduction.
      • Regularly: It should be the primary place you conduct your regular business activities. That doesn’t mean that you have to use it every day nor does it stop you from doing work outside the office, but it should be the primary place for business activities such as recordkeeping, billing, making appointments, ordering equipment, or storing supplies.
    3. Mixing up your other work. If you are an employee for someone else in addition to running your own business, be careful in using your home office to do work for your employer. Generally, IRS rules state you can use a home office deduction as an employee only if your employer doesn’t provide you with a local office to work at. Unfortunately, this means if you run a side business out of your home office, you cannot also bring work home from your employer’s office and do it in your home office. That would invalidate your use of the home office deduction.
    4. The recapture problem. If you have been using your home office deduction, including depreciating part of your home, you could be in for a future tax surprise. When you later sell your home you will need to account for this depreciation. This depreciation recapture rule creates a possible tax liability for many unsuspecting home office users.
    5. Not getting help. There are special rules that apply to your use of the home office deduction if:
      • You are an employee of someone else.
      • You are running a daycare or assisted living facility out of your home.
      • You have a business renting out your primary residence or a vacation home.

The home office deduction can be tricky, so be sure to ask for help, especially if you fall under one of these cases.

Things to remember

Recognizing the home office deduction complexity, the IRS created a simplified “safe harbor” home office deduction. You simply take the square footage of your office, up to 300 square feet, and multiply it by $5. This gives you a potential $1,500 maximum deduction. However, your savings could be much greater than $1,500, so it’s often worth getting help to calculate your full deduction.

Finally, if you are concerned about a potential future audit, take a photo or two of your home office. This is especially important if you move. That way if you are ever challenged, you can visually attempt to show your compliance to the rules.