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Many start-up businesses move from hobby status to a business when they start to make a profit. The taxing entity typically used is a sole proprietorship. Taxes on this business activity type flow through your personal tax return on a Schedule C. This type of business form has many benefits:
Fewer tax forms and filings. As a sole proprietor, your business activity is reported on a Schedule C within your personal Form 1040 tax return. Other business types like an S corporation, C corporation or a partnership must file separate tax returns, which makes tax compliance a lot more complicated.
More control over revenue and expense. You often have more control over the taxable income of your small business as a sole proprietor. This can provide more flexibility in determining the timing of some of your revenue and business expenses, which can be used as a great tax planning tool.
Funding a retirement account. You can also reduce your business’s taxable income by placing some of the profits into a retirement account like an IRA. As a sole proprietor, you can readily manage your marginal tax rate by controlling the amount you wish to set aside in this pre-tax retirement account.
It’s not all roses. While there are many benefits of running your business as a sole proprietor, don’t forget the drawbacks. One of the most significant drawbacks is the lack of personal legal protection, which is a feature in other business forms like corporations and Limited Liability Companies. Most sole proprietors address this with proper business insurance, so do not overlook the need to find coverage for yourself.
Please call if you have questions about your sole proprietor business.
Most financial experts suggest keeping three to six months’ worth of household expenses in savings to help in case of emergency. But with record inflation, that task just got a lot harder to accomplish as virtually every safe place to put your emergency funds will not provide interest rates that keep pace with inflation. But that does not mean you cannot increase the rate of return on these funds. Here are some ideas to reduce the impact of inflation on your emergency funds:
Creative use of Roth IRA funds in an emergency. Roth IRAs are funded with after-tax dollars. Because of this, early removal of the initial contribution is tax and penalty-free. If you dip into the earnings, however, you will not only be subject to income tax, but also may be subject to a 10% early withdrawal penalty. What you need to know: Use of a Roth IRA is often a creative way to fund your emergency account while achieving higher returns with conservative investment choices, but it is not for the faint of heart. If you get this one wrong, it could cost you in taxes, penalties, and lost fund value in a bear market. Prior to removing funds from any IRA, it makes sense to conduct a tax planning session.
Please call if you have questions about how to reduce the impact of inflation on your emergency fund.
Interest rates are expected to increase this year in response to inflation that is running at a 40-year high. How will you be affected? Any interest rate revision can cause a ripple effect throughout the economy. Accordingly, the Federal Reserve’s actions probably will exert at least a moderate influence over financial choices that you may make at home and in your business in 2022 and beyond. Here are some things to consider when making financial decisions during rate changes:
As a consumer, you stand to gain from rising interest rates because you’ll likely earn a better return on your deposits. Over the last ten years, placing your money in a certificate of deposit or passbook savings account has been hardly more profitable than stuffing it under a mattress. On the other hand, the cost of borrowing money will likely increase. As a result, mortgages, car loans, and credit cards will demand higher interest rates. That’s not a big deal if you’re already locked into low-interest fixed-rate loans. But if you have a variable rate loan or carry balances on your credit cards, you may find your monthly payments starting to increase.
On the investment front, market volatility may increase because rate increases are not completely predictable. Market sectors will likely exhibit varied responses to changes in interest rates. Those sectors that are less dependent on discretionary income may be less affected – after all, you need to buy gas, clothes, and groceries regardless of changes in interest rates. As you adjust your financial plan, you might only need to make minor changes. Staying the course with a well-diversified retirement portfolio is still a prudent strategy. However, you may want to review your investment allocations.
Rising interest rates can also affect your business. If your company’s balance sheet has variable-rate debt, rising interest rates can affect your bottom line and possibly your plans for growth. As the cost of borrowing increases, taking out loans for new equipment or financing expansion with credit may become less desirable.
Please call if you have questions about deciding on the most beneficial response to potential future changes in interest rates.
With the ups and downs of our economy over the last 2 years, you may have had a loan or credit card balance forgiven or canceled by a financial institution. You would think that the cancellation of debt by a credit card company or mortgage company would be a good thing for you and your family. And it can be, but it can also be considered taxable income by the IRS. Here is a quick review of various debt cancellation situations:
If you have gone through some type of credit workout program on consumer debt, it’s likely that some of your debt has been canceled. If that is the case, be prepared to receive IRS Form 1099-C representing the amount of debt canceled. The IRS considers that amount taxable income to you, and they expect to see it reported on your tax return. The exception is if you file for bankruptcy. With bankruptcy, generally, the debt canceled is not taxable. Even if you are not legally bankrupt, you might be technically insolvent where your liabilities exceed your assets. If this is the case, you can exclude your debt cancellation income by reporting your financial condition and filing IRS Form 982 with your tax return.
If your primary home is short sold or foreclosed and the lender receives less than the total amount of the outstanding loan, expect that amount of debt cancellation to be reported to you and the IRS. But special rules allow you to exclude up to $2 million in cancellation income in many circumstances. You will again need to complete IRS Form 982, but the exclusion from taxable income brought about by the debt cancellation on your primary residence is incredibly liberal. So make sure to take advantage of these rules should they apply to you.
If your school closes while enrolled or soon after you withdraw, you may be eligible to discharge your federal student loan and not include the forgiven amount as taxable income. You also may be eligible to exclude from taxable income any student loans discharged due to your school misleading you or engaging in other misconduct in violation of certain state laws.
The rules for debt cancellation on second homes, rental property, and investment or business property can be extremely complicated. Given your cost of these properties, your financial condition, and the amount of debt canceled, it’s still possible to have this debt cancellation income taxed at a preferred capital gains rate, or even considered not taxable at all.
Please call if you have questions about how a cancellation of debt situation applies to you.