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Taxes

Ten Tax Mistakes to Avoid

Tax Planning Gives You Control of Your Outcome By Teresa Bilsky Most all investors, business owners, and even individual taxpayers have experienced that sinking feeling of receiving a letter from the Internal Revenue Service or reviewing their tax return with different results than they expected. Your rental property lost money, so why aren’t you seeing the savings in taxes? Or perhaps you received a penalty letter citing some obscure tax code that you were expected to know! Though there is a wealth of information available (some accurate, some that could land you in jail, some that used to be accurate but is no longer so, and some that is comprised of lots of half-truths), the bottom line is that you are expected to know and understand the laws. Penalties sting, but the real issue that taxpayers are wasting millions of dollars on are missed opportunities. So, where do you begin? Begin with the basics. 1. Missing Filing Deadlines Filing deadlines are absolute. Missing them creates penalties that may not be deductible as an expense. For example, 1099-NECs are required to be filed by Jan. 31 regardless of submission method. Penalties range from $50 to $290 per form. Though there is not a deadline for obtaining the W-9 tax information needed to complete the 1099-NEC in a timely manner, we recommend that businesses obtain a completed W-9 prior to any contractor payments. 2. Federal Tax Extensions Extensions are available to allow for the accurate reporting of tax transactions as well as required disclosures. However, money is due when money is due. Extensions do not apply to the payment of tax. Avoid costly penalties and interest by knowing how much you owe by the due date. The failure to file/failure to pay penalty is the federal short-term rate plus 3%, compounded daily. 3. Estimated Tax Payments These payments are due in April, June, September, and January and should equal 25% of the required minimum amount. You often hear these payments referred to as quarterly tax payments though there is humor in that Congress apparently cannot count in threes. The time between Jan. 16 and April 15 is used to complete the calculation of the actual tax due. Payments are due with the return or extension filing by April 15. Business owners receiving a W-2 from their entity may meet this requirement with withholding regardless of the when, or how many times a payroll is received during the year. The law treats W-2s as having been paid equally throughout the year. Missing those due dates by even one day subjects that portion of the tax to the failure to file/failure to pay penalty. This is such a common penalty and common waste of money that there is a box for it on the personal tax return, form 1040. 4. Tax Liability The IRS announced that beginning in October 2023, the interest rate for underpayment or late payment of tax will increase to 8% in addition to the 5%-10% late payment penalty. Generally, the required minimum tax is either 100% of your tax liability from your prior year return or 90% of the current year liability. For an Adjusted Gross Income over $150,000, you need to pay 110% of the prior year or 100% of the current year to reach Safe Harbor. The Safe Harbor date is Jan. 15. Safe Harbor means meeting this required prepayment which grants you the January to April time frame to complete your total tax estimate. Many states follow the same time frame and concept. 5. Holding Period Oh, what a difference a day can make. Closing on a sale held 365 days or less is taxed as ordinary income. The 2023 highest rate is 37%. For long term capital gain treatment, the holding period is a year and a day. Capital gains are taxed between 0%-20%. The additional 17% in tax for that one day is a lot of your money. 6. Real Estate Professional Rules The “Good” and the “Bad.” The Good — Real Estate Professionals are not subject to passive activity loss limitations (PAL) on their rental activities. Nor are they subject to the 3.8% Net Investment Income Tax. The Bad— they are subject to the 15.3% Self-Employment Tax on rental activity profits. You must understand the annual election rules. To qualify, 750 hours must be dedicated to real estate activities AND more than 50% of service income must derive from those activities. Paying off the mortgage on a rental property may cost you more than you think you are saving. 7. Tracking Business Activities Accounting for income and expenses is essential to saving on taxes and for avoiding or repeating costly mistakes. Many business owners use personal money which is never visible and rarely remembered when recapping activates, once a year. With the top tax rate at 37% and the Self-Employment Tax at 15.3% for a total of 52.3%, EVERY dollar matters. Tracking expenses goes beyond saving taxes, it also provides feedback on areas where you may be bleeding money in small amounts that add up but are not easily felt during your day-to-day activity. Properly accounting for your expenses includes recording non-cash transactions such as depreciation, recording deductible portions of mortgage payments and so on. Some transactions should be tracked even though the tax benefit is limited or disallowed in order to have a complete understanding of how your business is performing. 8. Use Entities There are over one-million words in the US Tax Code. Use them all Entity structures are designed to help with various issues including taxes. Understand the differences and optimize the opportunities to report the very same activities and very same numbers on different pieces of paper for very different outcomes. Also understand when the entity is completely ignored by the IRS. Most importantly, using an entity goes beyond forming it. A business entity must have its own ID and its own bank account. Track and report its own specific transactions. Treat them as a separate person. This is

Due Diligence

Tax Planning

The Secret to “Making Your Own Math” By Teresa Bilsky A business owner is interviewing accountants with a one-question interview, “What is two plus two?” Applicant after applicant answers four until finally an experienced applicant looks directly at the business owner and without any emotional reaction answers, “What do you want it to be?” Though this is intended to be merely humor, those who are experienced in tax planning smile because there is a great deal of truth in that final answer. Yes, you can have your investment and your money too. You can make your own math. You just need to know where to begin. We begin each new business, new investment, or tax plan with the exit strategy Why? Well because we need the destination to formulate the map. Step two is determining the most cost-effective way to achieve that journey. This is where the plan arises to acquire your investment and keep your money. But how? We use special game pieces we call tax laws. Tax planning is much like playing Tetris: New pieces are continually falling; existing pieces are continually changing, and you (the investor and taxpayer) are the player. You start slowly with a blank playing screen where you have more control; but the longer you play, the more the pieces add up, obstacles present themselves, and everything seems to speed up. Know your pieces The falling pieces are tax laws, tax court cases, IRS interpretations of laws, investments, financial resources, time, your desired effort, input and knowledge. Start with where you want to end up » Do you want to acquire wealth through owning and retaining real property? » How much wealth? » Do you want to buy and sell to obtain cash wealth? » How will you make the cash work for you? » Are you investing to accumulate assets for estate purposes? » Will you need the properties to provide cashflow? If so, when and how much? » Do you prefer to work with residential real estate or commercial? All of these questions tell you what type of tools you will need. Knowledge Even though business owners need general knowledge in areas far outside their expertise, remember that investing in real estate does not make you a tax expert. The penalties for tax mistakes – both overpayment and financial losses for underpayment – are serious. The IRS does not care what you know; they only care about the rules and the money. Why do the tools change? The market changes, future earning capabilities change, buyers change, and Congress goes into session and the rules change. However, the most important factor is you. You change. Your knowledge and experience grow. Your portfolio grows. Your plan changes. Let’s start with some basics: You need to know what your assets are and what they are worth. All of your assets should be working for you in some way. I have yet to see that money stuffed in a coffee can duplicates in any way. Identify your assets and their value, then put them to work. Understand that the same piece of real estate may be presented with three different values depending on who is viewing the value and the purpose for the valuation. A written appraisal is based on the opinion of the market value by a professional trained to make those determinations which generally satisfies lending requirements. A valuation of the same property may arrive at a different number because it includes influences such as location, zoning restrictions, life expectancy of the building, and other permanent factors. Valuations have legal standing because they provide a definitive value. A good example of this is the tax court case for the Estate of Michael Jackson. The entire case was a dispute about the valuation of his assets at the time of his death. Finally, a financial statement would reflect the value in terms of basis without regard to market value. Let’s talk money. How do you keep more of your own money? You plan. The difference between tax preparation and tax planning is the answer to the question of “How much is two plus two?” Taxpayers in general should not wait for the tax return to be prepared before knowing where they will be for the year. They should already know. Tax preparation is reporting the results of the decisions you made in the prior year. Tax planning is impacting the outcome. We begin in the fall because it is late enough to project the income and early enough to achieve the desired results. Take charge of your pieces to impact the outcome by using the different tools available. If you are planning to acquire real estate to leave in your estate then know that the basis is stepped up at the time of your passing. A stepped-up basis means your beneficiaries get the tax benefit of the value of the asset at time of your death and not the basis you possess in the property, hence the dispute on the Michael Jackson case. A 1031 Exchange is a good tool to defer taxes on gains. As with any tax tool in the toolbox there are rules. The idea is simple: If you are allowed to defer tax on a gain by reinvesting into a bigger project that generates a larger gain, then government will see a larger return in the form of more tax. This is a great tool but it isn’t designed to help you, it is designed to generate more tax. However, it does benefit you because there is value in the use of money, also known as interest. The longer you get to defer taxes, the longer you get to use your money. You win. The more you grow an asset to produce a larger income, the more tax you generate, then they win. Investment in an Opportunity Zone is an advanced tool with rules by way of tax savings; this program encourages you to invest in economically depressed areas. Again,

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