Month: June 2021

Cryptocurrencies have gone mainstream. 

For example, you can use bitcoin to buy far more than you would think. To see, try googling “What can I buy with bitcoin?” You will get more than 350,000 hits.

But using cryptocurrencies has federal income tax implications that may surprise you. 

With the price of bitcoin having gone through the roof (before its recent decline), and with increasing acceptance of bitcoin and other cryptocurrencies as forms of payment, the tax implications of using cryptocurrencies are a hot-button issue for the IRS. 

The 2020 version of IRS Form 1040 (the form you recently filed or will file soon) asks whether you received, sold, sent, exchanged, or otherwise acquired—at any time during the year—any financial interest in any virtual currency. If you did, you are supposed to check the “Yes” box. 

The fact that this question appears on page 1 of Form 1040, right below the lines for supplying taxpayer information such as your name and address, indicates that the IRS is getting serious about enforcing compliance with the applicable tax rules. Fair warning!

The 2020 Form 1040 instructions clarify that virtual currency transactions for which you should check the “Yes” box include but are not limited to 

1. the receipt or transfer of virtual currency for free (i.e., without having to pay), 
2. the exchange of virtual currency for goods or services, 
3. the sale of virtual currency, 
4. the exchange of virtual currency for other property, and 
5. the disposition of a financial interest in virtual currency.

To arrive at the federal income tax results of a cryptocurrency transaction, the first step is to calculate the fair market value (FMV), measured in U.S. dollars, of the cryptocurrency on the date you receive it and on the date you use it to pay something. 

When you exchange cryptocurrency for other property, including U.S. dollars, a different cryptocurrency, services, or whatever, you must recognize taxable gain or loss just as you do when you make a stock sale in your taxable brokerage account. 

• You’ll have a taxable gain if the FMV of what you receive exceeds your basis in the cryptocurrency that you exchanged. 
• You’ll have a taxable loss if the FMV of what you receive is less than your basis in the cryptocurrency. 

It is hard to imagine that a cryptocurrency holding will be classified for federal income tax purposes as anything other than a capital asset—even if you use it to conduct business or personal transactions, as opposed to holding it for investment. Therefore, the taxable gain or loss from exchanging a cryptocurrency will be a short-term capital gain or loss or a long-term capital gain or loss, depending on how long you held the cryptocurrency before using it in a transaction.

Example. You use one bitcoin to buy tax-deductible supplies for your booming sole proprietorship business. On the date of the purchase, bitcoins are worth $55,000 each. So, you have a business deduction of $55,000.

But there’s another piece to this transaction: the tax gain or loss from holding the bitcoin and then spending it. 

Say you bought the bitcoin in January of this year for only $31,000. You have a $24,000 taxable gain from appreciation in the value of the bitcoin ($55,000 – $31,000). The $24,000 gain is a short-term capital gain because you did not hold the bitcoin for more than one year.

Detailed records are essential for compliance. Your records should include 

• the date when you received the cryptocurrency,
• its FMV on the date of receipt,
• the FMV on the date you exchanged it (for U.S. dollars or whatever),
• the cryptocurrency trading exchange that you used to determine FMV, and 
• your purpose for holding the currency (business, investment, or personal use). 

If you have questions about cryptocurrency, don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 16, 2021

What happens when lawmakers enact a new tax?

It starts small.

It looks easy.

In 1935, the self-employment tax topped out at $60. Those 1935 lawmakers must be twirling in their graves with the new rules for 2021, which levy the following taxes:

• A self-employment tax of up to $21,848, which comes from the 15.3 percent rate that applies to self-employment income of up to $142,800.
• A 2.9 percent tax that applies to all self-employment income in excess of the base amount. 

Beware

You know the expression “Don’t let the camel’s nose get under the tent”? It applies here. 

Look at what has happened to self-employment taxes since they first came into being in 1935, assuming you earn at the base amount:

• $60 in 1935
• $60 in 1949
• $3,175 in 1980
• $7,849 in 1990
• $14,413 in 2006
• $21,848 in 2021

To put the rates in perspective, say you are single and earn $150,000. On the last dollar you earned—dollar number $150,000—how much federal tax did you pay? The answer in round numbers—39 cents (14 cents in self-employment and 24 cents in federal income taxes).

Wow! That’s a lot. Then, if you live in a state with an income tax, add the state income tax on top of that. 

Tax Planning

Two things to know about tax planning:

1. Your new deductions give you benefits starting at your highest tax rates.
2. In most cases, the return on your planning is not a one-time event. Once your plan is in place, you reap the benefits year after year. Thus, good tax planning is like an annuity.

Checklist

Here is a short checklist of some tax-planning ideas. Review these ideas so you can identify new business deductions for your tax return. You want business deductions because business deductions reduce both your income and your self-employment taxes.

• Eliminate the word “friend” from your vocabulary. From now on, these people are sources of business, so start talking business and asking for referrals over meals and beverages.
• Hire your children. This creates tax deductions for you, and it creates non-taxable or very low taxed income for the children. Also, wages paid by parents to children are exempt from payroll taxes.
• Learn how to combine business and personal trips so that the personal side of your trip becomes part of your business deduction under the travel rules (for example, traveling by cruise ship to a convention on St. Thomas).
• Properly classify business expansion expenses as immediate tax deductions rather than depreciable, amortizable, or (ouch!) non-deductible capital costs.
• Properly identify deductible start-up expenses ($5,000 up-front and the balance amortized) rather than letting them fall by the wayside (a common oversight).
• Correctly classify business meals that qualify for the 100 percent deduction rather than the 50 percent deduction.
• Know the entertainment facility rules so your vacation home can become a tax deduction.
• Identify the vehicle deduction method that gives you the best deductions (choosing between the IRS mileage method and the actual expense method).
• Correctly identify your maximum business miles, so you deduct the largest possible percentage of your vehicles.
• Use a 1031 exchange to defer taxes (perhaps until death, when the tax code marks up your assets to fair market value and the income taxes disappear).
• Qualify your office in your home as an administrative office.
• Use allocation methods that make your home-office deductions larger.
• If you are married with no employees, hire your spouse and install a Section 105 medical plan to move your medical deductions to Schedule C for maximum benefits.
• Operate as a one-person S corporation to save self-employment taxes.
• If you are single with no employees, operate as a C corporation and install a Section 105 medical plan so you can deduct all your medical expenses.

If you would like my help implementing any of the ideas above, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 16, 2021

Disasters such as storms, fires, floods, freezes, and hurricanes can damage or destroy vital business records.

You need accounting and tax records not only to file your taxes (including claims for casualty losses), but to file insurance claims, bill clients, pay bills, obtain loans, deal with federal and state audits, determine business cash flow and solvency, and otherwise continue in business. 

Record reconstruction after a disaster may not be as hard as you think. It’s likely that much critical tax and financial data is already backed up online in the “cloud.” For example, your accounting software may perform online backups automatically without you even being aware of it.

Of course, not everything you need will be backed up online, particularly older items. Data on damaged or destroyed computer hard drives may be recoverable by experts.

To the extent you lack online backups, you’ll have to get copies of vital records from your bank, clients and customers, landlord, insurer, and government agencies such as the IRS.

After. The IRS recommends you document a disaster loss by taking photographs or videos as soon after the disaster as possible. 

Before. Also, check mobile phones or other cameras for pictures and videos before the disaster occurred.

Be prepared for the next disaster. Back up and safely store online in the cloud your most critical data: major contracts and legal documents, tax returns and financial statements, and other critical business and customer documents.

If you have any questions or need my assistance, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 8, 2021