Tax Planning

Income - In All its Glory

6/4/2020

You would think that income would be the easiest concept for a business owner to grasp. Doesn’t it seem completely obvious to you? Isn’t it all the money that came in – or was deposited into the business bank account?

Well, it turns out, not every business has established a separate bank account – so it’s necessary to separate personal funds from business funds.

Even businesses with separate bank accounts often make deposits or receive income in the wrong account – once again, that needs to be reconciled.

One of the most common issues I have seen working with small business owners who kept their own records (often on Quicken®) is they included all deposits as business income. Can you just imagine how much of a hero I was when I told them that they overstated their income by $10,000 or more! These are the kinds of deposits I would find on their business Profit and Loss Statements.

Can you tell which of these are business income?

Client reimbursement of your out-of-pocket expenses
Customer’s payment for completed work
Your money, deposited to prevent an overdraft
Cash advance from a credit card or your home equity
Royalty for the oil under your home
Money from investors or partners
Money you borrow from Mom (Shhh. Don’t tell Dad.)
Insurance settlement for your pain and suffering arising from a work-related auto accident
Money you took from your IRA to cover payroll
Repayments of advances you took earlier

The following items were either not income at all; or were not business income.

Numbers 3, 4, 6, 7,10 are not income at all. That amounts to half of those deposits!

Number 5 is personal income, reported on Schedule E.

Number 6 is capital – remember we talked about funds from investors in the past?

Number 8 is personal income – but it’s not taxable at all!

Number 9 is personal income – and it’s a really bad idea to take distributions from retirement accounts to fund your business. Not only are the funds taxable, but if you are under age 59 ½, you might also have to pay a 10% early withdrawal penalty. And to make it all even worse, the administrator keeps 10% - 20% of the distribution as IRS withholding – BUT you’re paying taxes and penalties on the money you never even got!

So, what IS income?

It’s compensation – in any form whatsoever.

What is “whatsoever”? Well, it’s cash, checks, things – like the pig in Doc Hollywood, stocks or partnership interests, a year’s worth of manicures, clothing, dentistry, radio airtime, magazine advertising, etc. In other words, when you provide a product or service to someone and they pay you in any way at all, that’s compensation. Sometimes compensation is direct; sometimes, it’s barter.

And guess what? Even all the barter is considered taxable income and must be reported – by both parties to the transaction.

In fact, many years ago, I was involved in a landmark barter audit that the IRS was conducting. My client had not filed tax returns in 10 years – and it was my job to prepare those returns. He wasn’t the target of the IRS audit – his boss was. The IRS wanted him to be a witness, and had him by the short hairs, because he was a non-filer. To make a long story short, I tried my best to persuade him to include ALL of his barter income. I had to re-do some of the returns a few times, as I stumbled across more barter during the process, for some years. (Like $10,000 of dental work; over $5,000 for a vacation at a European villa…and other nifty trades.) In the end, I reported what I knew. Then came the criminal trial. The IRS attorney questioning him was able to produce a cancelled check for $80,000 made out to him in exchange for one of his boss’s products – that neither of them ever reported. Alas, that man was convicted and did some jail time.

Let’s not let that happen to any of you for, inadvertently, not reporting income!

Read Chapter 5 of Small Business Taxes Made Easy to learn more about income.

Learn more about how to improve your business – or your clients’ businesses. I am teaching a 12-part series of courses at CCH CPELink, based on the first 12 chapters of the book. Please join me – and invite your clients.

They will understand why they need to consult you to rebalance their tax and business plan each year.

The latest edition of my book, Small Business Taxes Made Easy contains complete updates about the business considerations, from the PATH Act of 2015, up to and including the Setting Every Community Up for Retirement Enhancement Act (SECURE Act) of 2019; and the Taxpayer Certainty and Disaster Tax Relief Act (TCDTRA) of 2019. The new book is available now in print, Kindle and audio!

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Eva Rosenberg, EA

Eva Rosenberg, EA is the publisher of TaxMama.com, where your tax questions are answered. Eva is the author of several books and ebooks, including Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and other tax courses at http://www.cpelink.com/teamtaxmama.

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- Consultation with Experts: While TaxBuzz AI provides valuable insights, it is crucial to consult with legal and tax experts to ensure the advice aligns with the latest legal developments and specific nuances of a particular situation.
- Verification of Information: Users are responsible for independently verifying the information provided by TaxBuzz AI, especially in instances where the advice generated is critical to decision-making.
- Educational Purposes: TaxBuzz AI is intended for educational and informational purposes only. It is not intended to provide specific legal or tax advice tailored to individual circumstances.
- Non-Endorsement: The use of TaxBuzz AI does not constitute an endorsement or guarantee of the accuracy of the information provided. Users are encouraged to corroborate the advice with other reliable sources.
By accessing and using TaxBuzz AI, you agree to abide by these terms and acknowledge the limitations outlined herein. We reserve the right to modify these terms at any time, and your continued use of TaxBuzz AI constitutes acceptance of any such modifications. If you do not agree with these terms, please refrain from using TaxBuzz AI.

TaxBuzz.com is a service of CountingWorks, Inc., 2549 Eastbuff Drive., #448 208, Newport Beach, CA 92660

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