Tax

The Payroll Protection Program (PPP) rules—they keep a-changin’. 

During the past month, the Small Business Administration (SBA) issued a new set of frequently asked questions (FAQs) and a new interim final rule, which in combination create the following good news for the Payroll Protection Program (PPP):

• More forgiveness. The $20,833 cap on corporate owner-employee compensation applies to cash compensation only. It’s not an overall compensation limit as the SBA had stated in its prior interim guidance. Under this new rule, the owner-employee can add retirement benefits on top of the cash compensation, creating a new higher cap.
• Escape owner status. You are not an owner-employee if you have less than a 5 percent ownership stake in a C or an S corporation. Therefore, the cap on forgiveness for this newly defined non-owner-employee is not $20,833 but rather $46,154.

The new rules override prior guidance and have significance for PPP loan forgiveness today—and perhaps for obtaining additional loan monies retroactively (if Congress reinstates the PPP along with a new second round for businesses that suffered a big drop in revenue).

Here’s one example of how the new rules benefit John, an S corporation owner.

Example. John, the sole owner and worker, operates his business as an S corporation. His 2019 W-2 shows $140,000 in Box 1, of which $20,000 is for health insurance. In addition, the S corporation pays state unemployment taxes of $500 on John’s income and contributes $20,000 to his pension plan.

Based on the facts in the example, the corporation is eligible for up to $25,000 of PPP loan forgiveness, as follows:

• $20,833 on John’s salary (the cap), which the corporation pays to John at his regular rate in less than 10 weeks during the covered period;
• $4,167 on John’s retirement ($20,000 x 20.83%); and
• zero on the unemployment taxes because they were paid out in January, before the covered period began.

Advantage. Prior guidance limited forgiveness to $20,833. John’s S corporation gains $4,167 in additional forgiveness thanks to the new FAQs, assuming that the S corporation’s loan amount is $25,000 or more (which is possible).

The good news in the new guidance is that the corporate retirement contributions on behalf of owner-employees now count for additional forgiveness when the owner-employee has cash compensation greater than $100,000. And with the C corporation, the new guidance allows health insurance for the owner-employee.

Remember, I am always here for you. If you would like to discuss your PPP with me, don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 14, 2020

If you’re considering moving to a different state, taxes in the new state may be the deciding factor—especially if you expect them to be lower. 

Consider All Applicable State and Local Taxes

If your objective is to move to a lower-tax state, it may seem like a no-brainer to move to one that has no personal income tax. But that’s not a no-brainer! 

You must consider all the taxes that can potentially apply to local residents—including property taxes and death taxes. 

One Case Study

Texas is “famous” for having no personal state income tax, while Colorado has a flat 4.63 percent personal state income tax rate. So, you might reasonably think it would be much cheaper taxwise to live in Texas than Colorado if you have a healthy income. Not necessarily! Here’s why. 

The property tax rate on a home in some Colorado Springs locales is about 0.49 percent of the property’s actual value, as determined by the county assessor. Say you move to one of these areas and buy a $500,000 home. Your annual property tax bill would be about $2,450.

Say your taxable income is $200,000. Your Colorado state income tax bill would be $9,260. Your combined property tax bill and state income tax bill would be about $11,710 ($2,450 + $9,260). 

According to the Dallas Central Appraisal District’s online property tax estimator, the annual property tax bill on a $500,000 home in some Dallas locales would be about $21,200, or about $17,800 if you’re over 65 or a surviving spouse. You would have no state income tax bill. 

In most areas within both Colorado Springs and Dallas, the combined state and local sales tax rate is 8.25 percent, so no difference there. 

So the relevant comparison for property and income taxes is $11,710 in Colorado Springs and about $21,200 (or $17,800 if you’re over 65 or a surviving spouse) in Dallas.

But if your income is really high, it could be the other way around—assuming you don’t buy a really expensive home in Dallas.

Finally, it’s important to know that the restaurants are better in Dallas. True!

Defang the State Tax Domicile Issue

If you decide to make a permanent move to a lower-tax state, it’s important to establish legal domicile there in order to decouple yourself from taxes in the state you came from. 

The exact definition of “legal domicile” varies from state to state. 

In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere. 

Because each state has its own rules regarding your domicile, you could wind up in the worst-case scenario—with two states claiming that you owe state taxes because you established domicile in the new state but did not successfully terminate domicile in the old state. 

Finally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that state death taxes are owed. Not good! 

If you are thinking of moving to another state, please don’t hesitate to ask me for help. My direct line is 408-778-9651.

• By Leon Clinton
• October 10, 2020

What is the unpardonable sin in an IRS audit?

Suppose you just received that lovely letter from the IRS telling you that you are the subject of an IRS audit.

What one record receives special attention? What one record can create a nightmare for you? What one record makes the IRS suspect that you are the keeper of lousy records?

Think of the record people most hate keeping. That’s the one we are talking about. You have probably guessed what that record might be.

Red-Flag Record for the IRS Examiner

Once your audit examination begins, the examiner likes to see this record. If the record is missing or lacking, the IRS examiner knows that your other records probably are lacking, too.

This record—the one you probably hate keeping—is the mileage log on your vehicle or vehicles.

The IRS notes that a taxpayer’s failure to keep a mileage log on vehicles indicates that the activity under examination is not being conducted in a businesslike manner.

Do as the Tax Form Says

As a one-owner or husband-and-wife-owned business, regardless of whether it’s a corporation, a partnership, or a proprietorship, you file a tax form that asks you for the following information about your vehicles:

1. Do you have evidence to support the business/investment use claimed? (If “yes,” is the evidence written?)
2. List your total business/investment miles on each vehicle.
3. List your total commuting miles on each vehicle.
4. List your total personal miles on each vehicle.

IRS Form 4562 has columns for answers to the above questions for up to six vehicles used by either a sole proprietor or an owner of more than 5 percent of a corporation, a partnership, or another entity.

The mileage log is the record of proof that you need to use for your answers to the tax form questions.

Do What the Audit Would Require

Above, we said to do as the IRS form says. For additional clarification, it is good to know what information the IRS, in a correspondence audit, requires you to provide related to that tax form:

1. Send copies of repair receipts, inspection slips, and other records showing total mileage for the year.
2. Send copies of logbooks and other records to support the business mileage claimed.
3. Provide a copy of your appointment book or calendar of business activities for the year.
4. If you are claiming actual expenses, provide copies of paid bills, invoices, and canceled checks for automobile expenses. These would include gas, oil, tires, repairs, insurance, interest, tags, taxes, parking fees, and tolls.
5. Send a copy of the bill of sale or other verification to establish your basis in the vehicle, including the trade-in of another vehicle.

Note that the IRS is looking for

• a match of the repair bill odometer reading with the mileage in your logbook;
• a match of the inspection slip odometer reading with the mileage in your logbook;
• the mileage between repair stops, to see whether that ties in with your claimed mileage; and
• a business purpose that ties in with your appointment book or other calendar of business activities.

Takeaways

If you want to avoid big trouble during an IRS audit, keep a good mileage log. This takes just minutes a day.

The mileage log is often one of the first records that an IRS examiner will look at. A good mileage log shows that you know the rules and you respect them. We have seen dozens and dozens of IRS audits end favorably and quickly upon presentation of a good mileage log.

On the other hand, a bad mileage log can turn your IRS examiner into an 800-pound gorilla.

Think of it this way: your mileage log gives you the choice to get in and out of the IRS audit quickly and with your wallet or to spend time with an 800-pound gorilla.

I’m happy to help you create a mileage log. If you would like my help, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 3, 2020