Nothing can be more distressing than receiving a letter from the IRS. Having tax debt can cause stress, high blood pressure, sleepless nights, and it can also cause a break down in family relationships (we see this often in marriages). At Howard Tax Prep, in our Chicago South Loop tax office, we help clients resolve their IRS tax debts and State tax debt once and for all.
So what can you do you need to solve tax problems? Here are the Top 5 things that you can do when you owe the IRS, and have tax debt.
In plain English your options are:
Don’t over pay!
Ask for a settlement.
Ask for A payment plan.
Ask them to waive the Fees.
Tell them Don’t blame me!
In IRS Speak and complicated tax language, your options are:
1. Have a competent, and experienced tax consultant review your return for MISSED DEDUCTIONS! I once found $6,000 in missed deductions that put my client into a lower tax bracket, netting her a large tax refundof over $2,000! To be honest, I was actually shocked that I found such a large tax deduction, because the missed tax deduction was something that every good Chicago tax preparershould know! 101. In plain English: Don’t over pay!
2. IRS Offer in compromise. We’re sure that you’ve heard the commercials promising to “settle your tax debt for pennies on the dollar.” While every good tax debt consultant dislikes the phrase “pennies on the dollar” in some cases you can settle your tax debt with a low payment. We’ve seen cases such as: $150,000 tax debt settled for $4,000; $20,000 tax debt settled for $50; and $200,000 tax debt settled for $10,000! Not only can you possibly lower your tax debt, while the IRS considers your offer, you have a little more time raise money for your tax debt. In plain English: Ask for a tax settlement.
3. IRS Installment agreement. When most people receive a letter from the IRS the very first thing they do is think of ways to pay down their tax debt. The IRS offers 3 types of installment plans for tax debt. IRS tax debt installment plans, are basically agreements to pay what you owe on a continual basis, over a defined period of time. In plain English: Ask for a tax debt payment plan.
4. IRSAbatement of penalties. This can reduce or eliminate your penalties. In plain English: Waive the Fees.
5.IRS Innocent spouse relief. This can free you from liability if your spouse (or ex-spouse) is the reason for your tax problems. In plain English: Don’t blame me!
Here in our Chicago South Loop Tax Preparation, and our Homewood Il, Tax preparation offices, we specialize in helping business owners and real estate investors reduce their tax liability. One topic that always comes up is the topic of self-employment taxes. Regardless of age, all individuals with self-employment income must pay self-employment taxes. Even if you have a regular W2 job, if you earn additional income through a side gig, then you have self-employment income. Self-employment income can be earned through rideshare (Uber or Lyft) driving, delivery driver (Doordash, GrubHub, Instacart, etc.) work, independent contractor work (construction, life insurance sales, cleaning business, etc.) selling things online (Mercari, Eba, Amazon, etc.) or simply selling dinners out of your home.
The government claims that the reason self-employed workers need to pay self-employment taxes (in addition to income taxes), is so that when business owners reach retirement age, they’ll be able to collect Social Security and Medicare part A (hospital insurance) benefits if they paid self-employment taxes for at least 10 years (40 quarters). It is important to note that self-employment taxes are paid on your net earnings from self-employment, not your entire business income. In this article, we will discuss:
What is the self-employment tax
How Much Are Self-Employment Taxes?
Do employees pay less in tax than self-employed people?
Individuals Subject to Self-Employment Taxes.
Net Earnings from Self-Employment.
What happens if I own two businesses?
What happens if you work a job and have side self-employment income?
Will having self-employment income allow me to write off everything?
Income Not Subject to Self-Employment Taxes.
If you own an unincorporated business, you likely pay at least three different federal taxes. These three taxes are:
Federal income taxes.
Social Security taxes.
Medicare taxes.
Social Security taxes and Medicare taxes are collectively called self-employment taxes.
The self-employment tax totals 15.3% and has two parts:
1.) 12.4 percent Social Security tax up to an annual income ceiling adjusted for inflation each year ($147,000 for 2022) 2.) 2.9 percent Medicare tax on all net earnings from self-employment.
If your self-employment income is more than $200,000 (if you’re single) or $250,000 (if you’re married filing jointly), you must pay an additional 0.9 percent Medicare tax on self-employment income over the applicable threshold for a total 3.8 percent Medicare tax.
Do employees pay less in taxes than self-employed people?
Excluding the additional Medicare tax that’s levied solely on employees, the self-employment tax rate is the same as the combined Social Security and Medicare payroll tax paid by employees and employers. But with employment, employers pay half of the taxes while withholding the other half from their employees’ wages.
At first glance, it looks as if W-2 employees personally pay half as much as the self-employed. But that’s not so. The tax code allows the self-employed to make up for some of this unfairness by allowing them to reduce net income subject to self-employment taxes by 7.65 percent and deduct on their Form 1040 half of their self-employment taxes.
Individuals Subject to the Self-Employment Tax.
You pay self-employment tax if you:
operate as a single-member LLC.
earn income on a 1099-NEC.
operate as a single-member LLC.
do business as a sole proprietor.
are a general partner in a partnership.
are an LLC member in a multi-member LLC.
or are a co-owner of any other business entity taxed as a partnership (there is an exemption for limited partners).
You determine if your activity is a business under the same rules you use for deducting business expenses. The general rule is that a business is an activity you engage in regularly and continuously to earn a profit. You don’t have to work at a business full-time, but it can’t be a sporadic activity.
Net Earnings from Self-Employment.
The self-employment tax is not a progressive tax. It starts immediately—on dollar one, once you have over $433 in Schedule C, E, or F net income from a business ($433 x 92.35 activity = $400 which is the starting amount that requires reporting of self-employment income, & the payment of self-employment taxes).
Example. Nancy earns $1,000 from her single-member LLC, and reports this income on Schedule C. Her net earnings from self-employment are $935 ($1,000 x 92.35 percent). Her self-employment tax is $143 ($935 x 15.3 percent).
Your net earnings from self-employment start with the gross income from your trade or business minus valid allowable business deductions. Because you get to deduct valid business expenses, it makes it even more important to keep up with your bookkeeping, so that you can identify the expenses that will allow you to lower your income tax and self-employment tax. It’s important to note that, personal itemized deductions (charity donations, property taxes, medical expenses, etc.) and “above-the-line” adjustments to income don’t decrease net earnings from self-employment.
What happens if I own two businesses?
If you have more than one business (say two Schedule Cs), you combine the net income or loss to determine your net earnings from self-employment. Thus, a loss from one business offsets the income from another profitable business. But all is not roses: when calculating net earnings from self-employment, you may not deduct:
Net operating loss carryovers from past years,
Deduction for health insurance premiums for the self-employed,
Contributions to a self-employed retirement plan such as an IRA, SEP-IRA, or 401(k).
Section 199A qualified business income deduction.
Deduction for one-half of your self-employment taxes.
What if I Have Both W-2 Wages and Self-Employment Income?
If you earn both W-2 wages and self-employment income, you count your W-2 first as if you had no self-employment income. If your W-2 wages exceed the annual ceiling ($147,000 in 2022), no Social Security taxes are due on any of your self-employment income. In this case, you pay less in taxes under the ordering rule because it allows you to use all or part of the Social Security wage ceiling with your employee income (taxed at 6.2 percent).
Will having self-employment income allow me to write off everything?
Despite what some may believe, becoming self-employed will NOT allow you to
Write off all your meals as a business expense.
Write off all the utility bills in your home.
Write off 100% of your cell phone usage.
Deduct the cost of taking your friends to sporting events or bars.
Deduct all your travel and transportation expenses.
Write off the entire cost of owning or renting a residence that contains your home office.
Some types of income are not subject to self-employment tax at all, including:
most rental income,
most dividend and interest income,
gain or loss from sales and dispositions of business property, and
S corporation distributions to shareholders.
S Corporation Distributions
The income earned by anS corporation passes through the business to the individual shareholders as dividends or distributions. Such pass-through S corporation income is not trade or business income to the shareholders and is not subject to self-employment taxes.
Key point. The S corporation is the one business form that can save its owners substantial self-employment taxes, which is why it is so popular. However, most first starting out don’t need a S-Corp as the cost to maintain the S-Corp, payroll, and bookkeeping will outweigh the benefits until you net at least $35,000-$40,000.
Example Jason owns a landscaping business that generates $100,000 in net profit. If he operates as a sole proprietor, 92.35 percent of his $100,000 net business income is net earnings from self-employment subject to self-employment taxes. Instead, he incorporates his business with him as the sole shareholder and works full-time in the business as the corporation’s employee. Jason has his corporation pay him $60,000 as employee salary, on which payroll taxes must be paid. In addition, the corporation distributes $40,000 to Jason during the year as a distribution. The $40,000 is not subject to self-employment taxes, saving $5,652 in taxes ($40,000 x 92.35 percent x 15.3 percent)
Here are five things to know from this article:
The self-employed must pay a 12.4 percent Social Security tax and a 2.9 to 3.8 percent Medicare tax on their net earnings from self-employment.
The 12.4 percent Social Security tax is subject to an annual income ceiling ($147,000 for 2022).
You must pay self-employment taxes if you earn income from a business, side hustle, or side gig that you report on Schedule C or F, co-own as a general partner in a partnership, or own as a member in a multimember LLC, or if you co-own any other business entity taxed as a partnership.
Net earnings from self-employment do not include real estate rental income (unless you provide services to tenants), dividend or interest income, or gain or loss from business property other than inventory.
Distributions from S corporations are not subject to self-employment taxes. S corporations must ordinarily treat shareholders who work in the corporate business as employees and pay them a reasonable W-2 salary
Although we’ve given you the basics, this is not an all-inclusive article. Should you have questions, or need business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office at 855-743-5765. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.
Here in our South Loop of Chicago Tax Preparationoffice, and our Homewood, Il tax preparation office, we specialize in tax preparation for real estate investors, and small business owners. Working with this client base, we come across many general contractors that operate 95% in cash. Although cash only taxpayers are entitled to tax deductions, they (like every other taxpayer) must have proof of income received, and proof of expenses incurred. While in most cases we can help taxpayers reconstruct their income and expenses, in some cases the IRS will deny the expenses due to lack of documentary (paper) evidence. In the tax court case of NNABUGWU C. EZE, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, not only did the taxpayer lack documentary evidence for expenses, he also didn’t have proof of income received.
In 2015, and 2016 NNABUGWU C. EZE, owned and operated 2 sole proprietor businesses: a consulting business, and a residential construction business (while we’ll touch on issues related to the consulting business, the main focus of this article will be the residential construction business). “For 2015 he reported taxable income of $3,314 and claimed a refund of $774. For 2016 he reported taxable income of zero and claimed a refund of $744.”1 For his consulting business, Eze claimed to have generated $142,675 in gross revenue, $30,533 in auto expenses, 2,815 in business travel, and $9,662 in other expenses.2 While his auto expenses were high, the return might have avoided audit had Mr. Eze not reported that his construction business spent $99,275 (business expenses) to generate $27,875 in gross revenue. In the court opinion, the court noted that Mr. Eze:
Described his Schedule C2 business as “home improvement.”
Allegedly “did handyman, construction, and residential rehabilitation projects for individual customers.”
Claimed to have written contracts with his customers, but never produced the contracts into evidence.
Didn’t specify how he was paid by his customers, or what type of arrangements he had with his customers.
The court also noted that:
There was no proof of electronic or paper (documentary evidence) invoices being submitted to customers.
There were no bank statements to prove the income or expenses claimed on his schedule C profit and loss.
None of his alleged customers reported payments to him on Forms 1099-MISC, Miscellaneous Income.
As in typical fraudulent tax return behavior, the expenses reported on the tax return far exceeded the reported income.
Auto Deductions
When it comes to the business use of a vehicle, one of the best tax deductions for business owners is the ability to deduct either mileage, or actual expenses. In this case, Mr. Eze owned 3 vehicles: “a 2008 Mercedes Benz, a 2002 Ford SUV, and a 2004 Chrysler.”3 Mr. Eze testified that the Mercedes was used 100% in his consulting business; the Ford was used 100% in his residential construction business, and that he used the Chrysler “exclusively for personal and family purposes.” To prove that he drove the business mileage, Mr. Eze submitted a calendar with the places that he allegedly drove to for his consultation business, and a second calendar with drives for his construction business. Although Mr. Eze created the calendars, he couldn’t explain how he was able to remember information from 3-4 years ago. “When asked asked how he kept track of start and finish odometer readings for hundreds of trips, Mr. Eze said that he jotted them down on scraps of paper (since discarded)”4 to which the IRS responded kick rocks (okay, they actually said “we do not find that testimony credible”, but we like our version better). Since Mr. Eze couldn’t prove his business mileage (see our video here on how to prove business mileage), the mileage deduction wasn’t allowed.
Construction Expenses
To prove his construction material expenses, Mr. Eze submitted receipts from Home Depot, Lowes, and 84 lumber. While under oath, Mr. Eze stated that all of the purchases were not made by him, but some were made by his wife, and “maybe somebody else.”5 We find it odd that Mr. Eze can remember all of his business mileage locations from 4 years prior, but he can’t remember who the “somebody else” was that purchased materials from Home Depot. Some of the issues the court took with Mr. Eze material purchases were as follows:
All receipts are for cash purchases in excess of $5,000. Mr. Eze said he withdrew the money from his bank, yet he didn’t provide any bank statements, or record that would prove that. 6
He claimed to spend $175,000 for materials for a business that was unprofitable, and he somehow still paid his mortgage, private school tuition, and took care of 2 children. 7
The receipts for materials often show large-volume purchases- on the order of 200 pieces of lumber, 50 sheets of gypsum wallboard, and 100 gallons of paint. These volumes vastly exceeded what would have been needed for the projects shown on petitioner’s mileage log.8
The receipts often show purchases of items that petitioner could not possibly have used in any project that he allegedly undertook during the ensuing months. For example, the receipts show purchases of bathtubs, shower units, and refrigerators, but petitioner could not identify any project that would have required installation of such items. He testified that he made advance purchases of these materials and stored them in his garage until he needed them.9
Petitioner allegedly spent more than $21,000 on tools, but he was unable to explain the function or intended operation of many machines and tools listed on the receipts. He said that he could not remember what these things were used for, having purchased them years ago.10
As we read further into this case, it was clear to us that Mr. Eze thought that the IRS, and the courts were either stupid, or that they wouldn’t look at the documentation he provided. To illustrate, in one instance, Mr. Eze tried to claim the tuition that he paid for his daughter’s tuition as a business education expenses. He also claimed AT&T cellphone expenses of over $2,000, but the AT&T bills submitted covered tv and internet service. Mr. Eze also submitted payments to cricket wireless, claiming that although he didn’t receive invoices from the company “he knew what he owed each month.”
While social media (TikTok, YouTube, & Facebook video’s) will have you believing that you can magically turn personal expenses into business tax deductions (by simply creating a LLC), the truth is that taxpayers have to prove that they are entitled to any business or personal tax deductions claimed. Although courts do have the power to allow approximations (under the Cohan rule if an expense is reasonable), there must be some factual basis for the estimate, and the deduction must not be subject to increased substantiation rules.
Here in our Chicago south loop tax preparationoffice, and our Homewood Illinois tax preparation office, we have heard from many people that were afraid of the IRS’s pending requirement of having platforms such as Venmo, Cashapp, PayPal, etc. start reporting transactions over $600 that the user received. In addition to platforms reporting, many people were afraid that their Zelle transactions would also be reported to the IRS; however, Zelle transactions are considered bank to bank transactions, so Zelle did not have a requirement to report. After much confusion, and protest, the IRS announced on December 23, 2022 that they will “delay for implementation of $600 reporting threshold for third-party payment platforms’ Forms 1099-K.”
To give you a little history, prior to the American Rescue Plan of 2021, third party network providers were required to issue a 1099-K once a user reached $20,000, or 200 transactions. The reporting only applied to goods and services transactions, not for things like paying your family & friends for dinner, sending gifts, etc. Once the American Rescue plan was passed, the threshold amounts were lowered to $600 as a way to catch tax cheats, or as the IRS likes to put it to “encourage voluntary tax compliance.” Now that you understand how the reporting threshold came to be, let’s talk about the change that the IRS announced on December 23, 2022.
Per IRS issue 2002-226 “The IRS released guidance today outlining that calendar year 2022 will be a transition period for implementation of the lowered threshold reporting for third-party settlement organizations (TPSOs) including Venmo, PayPal and CashApp that would have generated Form 1099-Ks for taxpayers. “The IRS and Treasury heard a number of concerns regarding the timeline of implementation of these changes under the American Rescue Plan,” said Acting IRS Commissioner Doug O’Donnell. “To help smooth the transition and ensure clarity for taxpayers, tax professionals and industry, the IRS will delay implementation of the 1099-K changes. The additional time will help reduce confusion during the upcoming 2023 tax filing season and provide more time for taxpayers to prepare and understand the new reporting requirements.”1
“The IRS and Treasury heard a number of concerns regarding the timeline of implementation of these changes under the American Rescue Plan,” said Acting IRS Commissioner Doug O’Donnell. “To help smooth the transition and ensure clarity for taxpayers, tax professionals and industry, the IRS will delay implementation of the 1099-K changes. The additional time will help reduce confusion during the upcoming 2023 tax filing season and provide more time for taxpayers to prepare and understand the new reporting requirements.”2
IRS issue 2002-226 also states “the change under the law is hugely important because tax compliance is higher when amounts are subject to information reporting, like the Form 1099-K. However, the IRS noted it must be managed carefully to help ensure that 1099-Ks are only issued to taxpayers who should receive them. In addition, it’s important that taxpayers understand what to do as a result of this reporting, and tax preparers and software providers have the information they need to assist taxpayers. Additional details on the delay will be available in the near future along with additional information to help taxpayers and the industry. For taxpayers who may have already received a 1099-K as a result of the statutory changes, the IRS is working rapidly to provide instructions and clarity so that taxpayers understand what to do.”3
Although the IRS is not requiring the reporting at the $600 threshold, you are still REQUIRED TO REPORT ALL INCOME RECEIVED from your side gig, hustle, small business, sole proprietorship etc. In our article from July 2022, we discuss the ways the IRS can find out if you’re hiding income from them.
Here in ourChicago south loop tax preparationoffice, and ourHomewood Illinois tax preparation office, we often work with clients that want to legally reduce their tax bill, without triggering an audit. For our self-employed clients that realize a net profit of $35,000-$40,000 we sometimes recommend that they utilize the S-Corp taxation option (rather than a disregarded entity taxation status), as the S-Corp option will allow them to take advantage of some pretty awesome tax deductions. Below are 3 end of the year things that S-Corps must make sure to have done.
MAKE SURE THAT YOU HAVE PAID YOURSELF A REASONABLE COMPENSATION VIA PAYROLL, AND THAT YOU HAVE PAID YOUR PAYROLL TAXES.
You likely formed an S corporation to save on self-employment taxes. If so, is your S corporation salary
nonexistent?
too low?
too high?
just right?
Getting the S corporation salary right is important. First, if it’s too low and you get caught by the IRS, you will pay not only income taxes and self-employment taxes on the too-low amount, but also both payroll and income tax penalties that can cost plenty. Second, in most cases, the IRS is going to expand the audit to cover three years and then add the income and penalties for those three years. Third, after being found out, you likely are now stuck with this higher salary, defeating your original purpose of saving on self-employment taxes. Make sure to work with your accountant to help figure out your salary. You should also make sure that you corporate minutes name your salary, and have documents that prove your salary is reasonable (you can use the market approach, the income approach, or the cost approach).
RENTAL OF PERSONAL RESIDENCE FOR UP TO 14 DAYS FOR TAX FREE INCOME.
If your S-Corp is paying you (or your spouse) as an individual rent to use your residential space for hosting business meetings, please do the following:
Research the going rate for conference/meeting room rental in your area. Please view our detailed YouTube video on how to use the 14 day free rental income tax rule, & find the rental rates that your S-Corp can pay individuals.
Invoice your corporation for room conference/meeting rental.
Create a conference/meeting room rental agreement, or order one from Howard Tax Prep LLC.
Write a check, send a zelle, cash app, etc. from your corporate bank account, to your personal bank account.
Document the business purpose with meeting minutes, & resolutions.
HOME OFFICE & CELLPHONE REIMBURSEMENT
If you operate as a corporation, your home-office deduction does not show on either your personal return or your corporate return if you have the corporation reimburse the office as an employee business expense. To reimburse as an employee business expense, you must do the 5 things listed below.
Have a written corporate reimbursement policy. We offer plans for home office, travel, and cellphone usage reimbursement.
Have employee (you) submit a reimbursement sheet, and keep track of cost for reimbursement.
Pay employee (you) from the corporation’s bank account.
Document business use of home office. For example, accounting, marketing, emailing clients, creating policies, planning meetings, etc.
LIST OF 12 MEETING IDEAS
Annual Meeting Minutes.
Recent Accomplishments.
Next Quarters Sales Goals.
Industry News.
Process Updates.
Customer/Client Feedback.
Design/Branding Review.
Marketing Plan.
Annual Budget Meeting.
Review of compliance records.
Board of Directors Decisions.
Annual Financial Performance Review.
Although we’ve given you the basics, this is not an all-inclusive article. Should you have questions, or need business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office at 855-743-5765. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.
To summarize, the guidance says that if a taxpayers PPP loan is forgiven based upon lies, or leaving things out (misrepresentations or omissions) the taxpayer cannot exclude the forgiven loan income from taxation; basically, you will have to pay taxes on the loan amount that you received.
According to the IRS, while many small business owners were entitled to receive the loan (and properly claimed the PPP loan forgiveness), there are many taxpayers who weren’t eligible for the loan, or loan forgiveness. Some taxpayers lied to receive the PPP loan funds, while other’s spent the loan proceeds on ineligible items.
Per IRS Issue Number IR-2022-162: “Under the terms of the PPP loan program, lenders can forgive the full amount of the loan if the loan recipient meets three conditions.
1 – The loan recipient was eligible to receive the PPP loan. An eligible loan recipient:
is a small business concern, independent contractor, eligible self-employed individual, sole proprietor, business concern, or a certain type of tax-exempt entity;
was in business on or before February 15, 2020; and
had employees or independent contractors who were paid for their services, or was a self-employed individual, sole proprietor or independent contractor.
2 – The loan proceeds had to be used to pay eligible expenses, such as payroll costs, rent, interest on the business’ mortgage, and utilities.
3 – The loan recipient had to apply for loan forgiveness. The loan forgiveness application required a loan recipient to attest to eligibility, verify certain financial information, and meet other legal qualifications.
If the 3 conditions above are met, then under the PPP loan program the forgiven portion is excluded from income. If the conditions are not met, then the amount of the loan proceeds that were forgiven but do not meet the conditions must be included in income and any additional income tax must be paid.”
Per IRS Issue Number IR-2022-162: “Taxpayers who inappropriately received forgiveness of their PPP loans are encouraged to take steps to come into compliance by, for example, filing amended returns that include forgiven loan proceed amounts in income.” In essence, if you know that you lied about how you spent the PPP (paycheck protection program) funds, take the lie back by amending (changing) your tax return to reflect the truth.
IRS Commissioner Chuck Retting said: “This action underscores the Internal Revenue Service’s commitment to ensuring that all taxpayers are paying their fair share of taxes.” “We want to make sure that those who are abusing such programs are held accountable, and we will be considering all available treatment and penalty streams to address the abuses.”
If you, or someone you know had a person “do your PPP loan” (complete the application, and get you the funds), and you need assistance with amending your tax return, please reach out to us for assistance.
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