A bipartisan group of around 70 lawmakers has asked the U.S. House of Representatives Ways and Means Committee to “fully consider the negative ramifications” of tax reform proposals that limit accounting flexibility for small businesses.
The House Ways and Means Committee has been working for quite some time on coming up with a comprehensive tax reform proposal.
They have held dozens of separate hearings, and created 11 different working groups.
If enacted and coupled with federal spending cuts, the legislation could create a million jobs in the first year alone.
However, it also creates a lot of changes in tax compliance. One of these proposed changes outlined in the draft Tax Reform Act of 2013 includes limitations on the use of cash accounting by pass-through entities, farms and professional service firms.
Once these firms grow to more than $10 million in gross receipts, they would have to switch to the more cumbersome accrual accounting method.
Cash accounting is a lot simpler since a transaction goes into the books only when cash is received or paid out.
Under accrual accounting, income is recorded when the sale is completed (as opposed to receipt of cash). Expenditures are likewise recorded only when an item is received (as opposed to when it is paid for).
More than 90 percent of all business entities in the U.S. are pass-through entities that include a wide array of sectors and professions including lawyers, engineers, physicians and dentists.
All of them, and other business entities taxed at the individual rate, prefer the simplicity of cash accounting.
Forcing a large number of these individuals to switch to the accrual method would be bothersome and expensive. It would also likely make their accounting process more costly in the long run.
The group of lawmakers sent a letter voicing their concerns about this limitation that was addressed to Committee Chairman Dave Camp (R-MI) and Ranking Member Sander Levin (D-MI), in which they write:-
“For many small businesses, mitigating the one-time costs of switching accounting methods would be extremely difficult, as would the continued use of the more complex accrual method of accounting.…Across sectors, small business owners are concerned at the possibility of complying with a more complex accounting system that requires them to report income before they receive the cash…it is our shared goal to simplify and reform the tax code into one that enables growth and competitiveness while reducing the cost of compliance and maintaining fairness.”
This letter has received support from the American Institute of CPAs.
Photo credit - taxreform.gov
There are plenty of ways to reduce taxes after retirement, and every tax professional you consult will go about it in a different way. But what it all essentially boils down to is three things – tax planning, tax brackets and social security income.
People start saving and plan for retirement while they’re still young. But the biggest impact on how much you actually end up with still comes from what you do between the ages of 55-70.
This is when you start making withdrawals, and there is an opportunity to reduce the tax you need to pay on your various income sources combined with social security benefits.
The planning here consists of what kind of account would be most helpful (eg: traditional or Roth IRA) and what kind of investments to make (cash, stocks, bonds, mutual funds, gold, property, etc.). This in turn depends on what tax bracket you are in now and what bracket you will likely be in various stages of your life leading up to and after retirement.
Let’s take a specific example with numbers. Tax-deferred individual retirement accounts (IRAs) and 401(k) accounts allow you to take distributions starting from age 59 ½, and you must start taking the required minimum from age 70 ½.
So let’s say you get the average of $15,000 in social security benefits as an individual and you withdraw $30,000 from your traditional IRA. Then your real income is $45,000, but the “combined income” is only $37,500.
The combined income here is calculated as half your social security benefits plus adjusted gross income and non-taxable interest.
If this combined income is between $25,000 to $34,000, you only pay taxes on 50 percent of the benefits. If it’s above $34,000, up to 85 percent of the benefits may be taxable.
The point here being that if you reduced your IRA withdrawal by around $4,000, your combined income stays below $34,000 and you pay tax on only 50 percent of the benefits.
Now if you had a Roth IRA where your contributions have already been taxed and withdrawals are tax-free, it wouldn’t matter how much you withdrew from the IRA.
The tax bracket likewise has a big impact. If you’re in higher tax bracket now and likely to be in a lower bracket after retirement, then it makes sense to open a traditional IRA and pay taxes on withdrawals after retirement.
On the other hand, if you plan to start a business or take up another job after retirement, it pushes you into a higher tax bracket, and it makes sense to open a Roth IRA so that you can pay off taxes in a lower tax bracket before you retire.
The investment portfolio likewise offers another opportunity to reduce the tax liability. Cash and bonds are taxed as income, and should be held in retirement accounts to avoid being taxed. Mutual funds and other stocks held for less than a year are likewise taxed at income tax rates.
Appreciation in the value of stocks held as long-term investments is taxed at a much lower rate as capital gains. Gold will be taxed at 28 percent.
Consider all this when making investments in retirement and non-retirement accounts.
These are just the basic factors that will help you reduce taxes after retirement. If you really want to make the most of it based on a careful analysis of your specific situation, then you need to get in touch with a retirement tax planner.
Photo credit - 401(K) 2013/flickr
Sales tax may be applicable at the state and local level, with small business owners expected to collect the sales tax from consumers and pass it on to the taxing authority.
The level of taxation varies in each state, and so does the additional sales tax imposed by local governments.
The key consideration, therefore, is the total amount of state and local sales tax imposed. You can get a fairly good idea of how this works in this post.
As far as a small business is concerned, you only have to collect and pay sales tax for sales in the location where you have a physical presence, as in a registered business.
Note that each state has a slightly different concept as to exactly what constitutes a physical presence, and when they consider a “nexus” to have been created.
Nexus in this context means the physical presence of a business in a state.
The Marketplace Fairness Act that is making its way through Congress would require online retailers to pay sales tax even if they do not have a physical presence in the customer’s home state.
But the bill in its current form applies only to businesses with annual sales exceeding $1 million. Small businesses which do not hit this amount would still be exempt from collecting sales tax on online out-of-state purchases.
Small businesses also do not have to pay sales tax on raw materials and other goods they sell to vendors who plan to resell the goods. Just make sure you collect a resale certificate to claim this exemption in your books.
Also exempt are sales to the federal government and tax-exempt organizations such as non-profits and religious/educational institutions.
Sales tax exemptions may additionally be available on specific types of goods and services such as food items, medicines and property. Enquire with the state and local regulatory bodies for a full list of exempted items and buyers.
In order to be eligible to collect sales tax, you need to register and apply for a state sales and use tax permit. Most states allow small businesses to apply online for a sales tax permit.
The amount of the sales tax imposed has to be mentioned separately in the receipt given to the customer. Both point-of-sale systems at physical locations as well as online eCommerce stores have provisions that allow you to program the amount of sales tax to be collected into the software.
The reporting requirements for sales tax again varies for each state and taxing authority. Most states allow sales tax to be paid online, and offer monthly, quarterly and annual reporting options.
The choices may be limited by the amount of sales. For instance, businesses that collect $300 or more in monthly sales tax in Colorado must file monthly, and those who collect more than $75,000 a year must pay via Electronic Funds Transfer (EFT).
On the other hand, those who collect less than $300 in sales tax in Colorado may file their sales tax returns quarterly.
Check with your state’s regulating authority about the sales tax reporting requirements for your small business.
Photo credit - Richard Masoner / Cyclelicious (flickr)