Today one of my really neat clients called me with a question about an IRA. First let me say, his son was a hot baseball prospect here in San Diego County. My clients son made it to the minor leagues. It’s pretty cool when you get a W-2 from the Atlanta Braves.
Anyway, the conversation went something like this.
“I have an IRA and I would like to cash a portion of the money out. Within my IRA I have a few stocks that are “dogs”. I lost X amount of dollars on these stocks so I thought I would cash them out along with a few stocks that made gains.”
Keep in mind here that this is not a traditional stock transaction. When stocks are in an IRA you cannot cancel out the “win” and “losses” the same way you can if they were just purchased as a stand alone stock. Let’s breakdown how a loss is handled in an IRA. Three factors need to be established:
“Basis” exists in the IRA
So what is basis? Basis for this purpose is “any money that you contributed to an IRA and did not receive an immediate tax benefit” When we contribute to an IRA we get the opportunity to deduct the amount off of our individual tax rate. In some instances this cannot be done due to one spouse or individual who is involved in a retirement plan and over the income threshold.
Clear out all IRA’s
Any traditional IRA you might have, this also includes SEP’s and SIMPLE’s that are set up as an IRA must be completely liquidated to realize a loss you had in an IRA. Again, you must have “basis” stated above first for consideration.
Loss is an Itemized deduction
So let’s say both criteria are met. You have basis in your IRA and you are liquidating all of your IRA’s. Now we can take the loss right? Well, not so fast. An IRA loss is subject to the 2%-of-adjusted-gross-income limit that applies to certain miscellaneous itemized deductions on Schedule A, Form 1040. For one thing, you need to clear the 2% of AGI before realizing loss but even still you need to itemize vs the standard deduction on your return. If you do not itemize you will not be able to take the IRA loss. If you can take the IRA loss it will reduce your taxable income. Remember, it’s not a dollar for dollar “credit”.
Researching your investments
It would behoove you to take a look at your IRA contributions over the years and rub them against your tax returns. It’s a sure thing many people do not know if they actually have “basis” in their IRA. Whether you made money in an IRA or lost money in an IRA it might not be taxable. This is a research project that can be of high value to you. Give to Caesar what is Caesar’s but why a penny more?
Tax Group of San Diego
4025 Camino Del Rio S Ste 300
San Diego, CA 92108
Tax Group of San Diego
100 E San Marcos Blvd Ste 400
San Marcos, CA. 92069
So often we hear about the men and women who start small businesses. Whether they need to rent a space brick and mortar style, or create a room in their house with an office and go virtual, the success and failure rate is hard to determine.
Let’s say one spouse doesn’t need the money as much as the other because that spouse is bringing in the dough to support the family. Unfortunately you don’t see too much of this in the under 40 crowd. Heck, I don’t see too much of this in the under 50 crowd as well! Let’s look at these folks as the “Hobby Entrepreneurs.” It’s just too tough to get hard numbers of the success rate on this group and the sole proprietor set up.
I recently read an article that stated less people are venturing off into their own businesses today than those of 10 years ago. With the recent recession, it seems as though there is a broad fear that has swept the nation.
If you think about people you know, can you name a few people that went past this decade and started a business on their own?
From a broad economic and sociological stand point we must take a look the reasons why we are seeing less people leave their jobs to live the “dream.” First and fourmost we have lost a vast amount of industries over the last few decades. When was the last time you saw a mom and pop video store open or even a computer repair place? The idea of renting retail space for a business is slowly going by the wayside unless you are a larger corporation or franchise.
Nowadays anyone can advertise as a small business on sites like Craigslist or your local Pennysaver. It would be absurb to rent retail space in many instances. Some businesses will never go away and seem to be thriving such as the restaurant and hospitality businesses. Here in Southern California we have seen a rash of Microbrew Eateries jump onto the scene over the past 10 years. Although were always told it’s the hardest business to succeed in, the entertainment/eatery business has a great chance to make it if you are delivering what the local population is looking for.
Getting back to my topic. Why are we scared to barge into our bosses office and tell him to “take this job and shove it ?” Well, let’s write down a number of factors as to why this is tougher to do today.
There is an answer to all this. Something else can be done. This something is in our control which can make (almost) everyone happier. Lower taxes. What more can be said? If you put more money back into everyone’s pockets then everyone has a better chance to accomplish their goals. If government wants to regulate, then regulate salaries of government officials, overtime pay and frivolous spending. With all of the obstacles that are faced in starting your own business, at the least, they need give everyone a better chance to succeed.
In 1997 the deduction for student loan interest came back into play after being repealed in the mid-1980’s. It seems everyone knows someone that owes six figures for their college education.
What makes this sad is that even if they found their dream job within the field that they studied, the salary would not constitute the amount of money that they owe. When it comes to borrowing money its not so much the principle that makes it so hard to pay back but yet of course interest makes it disturbing to the borrower, especially when your first starting out in a career
What is the student loan interest deduction
Student loan interest is one of the unsecured loans that you actually cannot walk away from. It was less than a decade ago the Internal Revenue Service made a change to the student loan interest deduction. The former rules only allowed you to take the deduction within a certain time after graduation. Under the current rules the deduction can be taken for an unlimited amount of time after graduation if you are paying interest. You can find the deduction on line 33 of the 1040, they call it an “above the line deduction” which reduces your adjusted gross income.
What can Washington do?
With all of the talk about tax reform, how about we look at things “one at a time”. We have quite a few credits that will actually give you money for somewhat no reason whatsoever. The child tax credit is the government giving away money for having children. Earned income credit is giving money out to the poor. In one perspective, their is a social responsibility that was considered when these credit came about. Its nice to know the government will assist its citizens when they are in need however for some, their is an incentive to earn just enough and nothing more.
A reasonable solution
The student loan interest deduction is not a credit its only a deduction. What if we told our children that we, as American taxpayers, are willing to foot the bill for the interest that our youth are paying? . Like the earned income credit, were the government can sometime give over $5000 to individuals depending on how many children they have and what their income is (always worth a debate), we can give graduating students the incentive to not be so frustrated when its time to payback their loans. The proposal would be to move the student loan interest deduction to a student loan interest credit. The credit would have phase outs just like so many other credits and would balance compared to taking a deduction of the interest which only reduces taxable income. In essence the interest you pay for student loan debt will be given back as a credit and not just a deduction, especially a deduction that might not benefit you.
Tax Group of San Diego
4025 Camino Del Rio S #300
San Diego, CA. 92108
Tax Group of San Diego
100 E San Marcos Blvd Ste#400
San Marcos, CA. 92069
In an earlier post I had mentioned my main reason for becoming an S-Corp. If you did not read that article please click here . As a refresher, there is a tax advantage to becoming an S-Corp versus a sole proprietor or a C-Corp (however, there are some good advantages to becoming a C-Corp as well).
Unlike an LLC or C-Corporation the S-Corp can only have one type of stock. Let’s say you decide to acquire a shareholder, however, you are the one that has taken on the liability of many of the bills and purchasing of assets. In a case like this you would need to be careful with an S-Corp, especially if you are trying to create a complex relationship with the other shareholder(s).
Let’s say we have an LLC and we have 3 members. In an LLC we use the word “members” instead of shareholders and I will show you why. Johnny has $250,000 dollars to invest in his Sausage and Peppers food truck. (You can tell I’m Italian right :)). Johnny however, wants to motivate some hot dog guys from town so he calls Doug and Phil. Now, Doug and Phil know a thing or two about relish and sauerkraut…… heck, they were both born in Poland and have outstanding recipes.
Johnny brings these two valuable people into to the business. To give an incentive, Johnny tells them they can become members of the LLC. Johnny…. in a roundabout way can create any type of arrangement he wants with his business partners by handing over a share of his business. However, if Johnny were to make them shareholders in his S-Corporation, there isn’t a good and easy way to make them not part owners of the company.
If you want to bring on a business partner in an S-Corporation, your choice of an individual should be rock solid. You also should have a clear understanding that they are a shareholder(owner) of the company and are entitled to a percentage as owner of the company. It’s not easy to go into business with anybody. It’s your business marriage. Therefore, be even more mindful when doing so under a corporation especially and S-Corp.
Your average person can spend weeks and even months researching, investigating and analyzing the benefits of incorporating. It’s almost like someone decided to create a perplexing process of getting information with regards to entity choices. So, what are your choices? You have the S-Corp, C-Corp, Sole Proprietorship, LLC and the Partnership. Today we are going to focus on the S-Corp. The other day I was on the phone with one of my favorite clients. Let’s call him Sal. I really like Sal. He just turned 30 and is a very hard worker. I emphasize to him that he is a rare individual. I say Sal is special because prior to 30 he has been in business for the past 5 years and that alone is a feat in itself. Being in business and growing before 30 is not as common as we might think.
Sal calls me up and tells me that he really needs time to talk with me regarding: “Should he go forward with moving his accounting over to the S-Corporation?” I knew I was in for a treat because Sal is smart. He does his homework. Well, 2 hours later and a lot of back and forth we concluded that the S-Corp entity choice was right for him.
I was challenged that day and I decided to write this article. The next time a client calls me with regards to an S-Corp, I will lead him to my article. Here are the laymens terms on this topic.
As far as I can see, the absolute best reason to become an S-Corporation is that: An individual can waive an amount near 50% of his net profit that is subject to Social Security and Medicare tax (FICA). Now..listen carefully, this is not etched in stone. The percentage might be higher and might be lower depending on your role within the company. Let’s lay out some numbers.
If Sal makes $100,000 profit as a sole proprietor every single dime of that money is taxed at his income tax rate as well as the FICA tax.
If Sal was an S-Corp or taxed as an S-Corp (which an LLC can do, we can talk about that another day) he would have been able, depending on his role in the business to take $50,000 away from being taxed the FICA. The full amount is subject to federal income tax however, he does not pay payroll tax on the other 50%.
I caution small business owners about incorporating until they at least have 3 years in business especially if it is a low liability business. I have met too many people who started corporations prior to really having all that much business experience. The fees associated with incorparation, tax filing and here in California the “Franchise Fee” (this has nothing to do with a franchise) is way too much when you’re first starting out. The moral of the story is
Be Like Sal.