Small Business – Charles Zeugner, CPA

Common Tax Myths – Travel, Meals and Entertainment

There are many things that are “common knowledge” about income taxes. Unfortunately, some of them are simply wrong. This short series of blog posts will address some of them. This post examines some myths about travel, meals and entertainment deductions.

Go on and spend the money, it is deductible.

This common refrain covers a lot of territory. It typically only affects business owners, although taxpayers with large amounts of unreimbursed employee business expenses also succumb to this. (Recent changes to tax laws have affected the rules regarding unreimbursed business expenses.) Not all expenses are deductible. You can refer to Publication 463 Travel, Entertainment, Gift, and Car Expenses for specifics. There is a table listing types of expenses that are deductible if they are incurred for a bona fide business purpose near the end of this post. Keep in mind that even when expenses are deductible, they are still expenses.

Talk about business so your lunch or dinner can be a business expense.

This is an example of an expense that is not deductible. Simply talking about business does not make something a business meeting. While meals and entertainment can be deductible, there must be a bona fide business reason.

In plain terms, expenses for business should be ordinary and necessary. The IRS defines these terms in Publication 535 Business Expenses.

To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

Even a casual reading of this definition makes it clear that meeting a client or prospective client for dinner may be a deductible expense. So too might be a lunch meeting with a coworker or employee if the purpose is directly related to business. However, it is not appropriate to deduct the expense for routine meals. You may be able to expense regular meals for employees in some circumstances. Deductibility may also depend on the nature of your business. You should consult with your tax advisor for the details.

Two common myths have to do with the cost of meals.

Go on and go to the fancy place, its deductible.
Don’t try to deduct very expensive meals.

As usual, the truth is something else. Pub 463 addresses the topic of lavish or extravagant meals.

You can’t deduct expenses for meals that are lavish or extravagant. An expense isn’t considered lavish or extravagant if it is reasonable based on the facts and circumstances. Expenses won’t be disallowed merely because they are more than a fixed dollar amount or take place at deluxe restaurants, hotels, nightclubs, or resorts.

In other words, cost by itself will not affect whether you can deduct an expense. Remember the definition of ordinary and necessary described earlier. Keep in mind that even though the expense may be deductible, meal and entertainment expenses are limited to 50 percent of the actual expense or standard meal allowance amount.

If you go on a business trip, you can stay a few extra days and write off the expense. If you take along a companion, that is deductible also.

Bad idea. IRS Publication 535 Business Expenses explains,

Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.

Using this as a guide, you would be able to deduct the business portion of your trip. However, expenses for extra days or for companions are personal expenses and are not deductible as business expenses.

Another variation on this theme is:

If your small business has annual meetings, hold them in places that are also resort or vacation destinations, so you can write off the trip.

This may be partly true depending on the circumstances, but like many myths, it starts with truth and then distorts into falsehood. The expenses associated with your businesses meetings are deductible if they have a business purpose. Once you go beyond the bona fide business purpose, then the expenses are no longer deductible. Be very careful about trying to deduct that wintertime company meeting at a beach resort. The details about what are likely to be acceptable may depend on the nature of your business. You should consult with your tax professional.

The table below lists the types of travel expenses that you can deduct. Remember to keep receipts and documentation.

Travel Expenses You Can Deduct

IF you have expenses for...	THEN you can deduct the cost of...
transportation	travel by airplane, train, bus, or car between your home and your business destination. If you were provided with a free ticket or you are riding free as a result of a frequent traveler or similar program, your cost is zero. If you travel by ship, see Luxury Water Travel and Cruise Ships , under Conventions, earlier, for additional rules and limits.
taxi, commuter bus, and airport limousine	fares for these and other types of transportation that take you between: The airport or station and your hotel; and The hotel and the work location of your customers or clients, your business meeting place, or your temporary work location.
baggage and shipping	sending baggage and sample or display material between your regular and temporary work locations.
car	operating and maintaining your car when traveling away from home on business. You can deduct actual expenses or the standard mileage rate, as well as business-related tolls and parking. If you rent a car while away from home on business, you can deduct only the business-use portion of the expenses.
lodging and meals	your lodging and meals if your business trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. Meals include amounts spent for food, beverages, taxes, and related tips. See Meals , later, for additional rules and limits.
cleaning	dry cleaning and laundry.
telephone	business calls while on your business trip. This includes business communication by fax machine or other communication devices.
tips	tips you pay for any expenses in this chart.
other	other similar ordinary and necessary expenses related to your business travel. These expenses might include transportation to or from a business meal, public stenographer's fees, computer rental fees, and operating and maintaining a house trailer.

Excerpted from Publication 463 Travel, Entertainment, Gift, and Car Expenses

Don’t become a victim of tax myths. “Everybody does it” is not a good defense if your deductions are questioned. If you have travel or meals and entertainment expenses for your business, be sure to deduct them. However, make sure that they are for a legitimate business purpose and that you can substantiate them.

Save Money on Tax Preparation

Paying a lot for tax preparation? Paying a CPA, Enrolled Agent, attorney or other professional to prepare tax returns does not have to be expensive. Hiring an expert may be a good idea, and most of the fees are money well spent. However, some habits could be costing you a lot of money, and they could lead to errors. What are these habits?

Disorganization
Inadequate Records or sloppy bookkeeping
Unresponsiveness

This is how those habits cost you and what you can do about them.

Disorganization

At tax time many people simply gather up any documents they think might somehow be related to their income tax, stuff them in folders or large envelopes, and send them to their CPA. The tax preparer will review and make copies of everything. Many of the documents will turn out to be unnecessary. Even so, once their CPAs start going through the files, they find that many important items are not included. The CPA will then have to contact the client and ask for the missing documents. This adds to the expense of preparing the return because the accountant spends additional time and expense on the unnecessary items and the spends extra time tracking down the missing items. Ask your CPA or tax professional for an organizer or checklist.

Inadequate Records or Sloppy bookkeeping

The IRS requires taxpayers to document income and expenses. Without documentation, the IRS will disallow many deductions or credits. If you worked and received a salary or wage, then your income and any withholding will be documented by your employer with a W-2. If you were a contractor, then you will receive a Form 1099-MISC if you were paid more than $599 during the year.

Income from banks or brokerage accounts will be documented with various 1099s for interest, dividends, or capital gains.

On the expense side, individuals may be able to deduct charitable contributions, interest, some, medical expenses, and many other things. Depending on the expense, you will have received some sort of document explaining the expense.

If you own a business, you will also have to document your income and expenses. Many businesses hire bookkeepers to keep track of their income and expenses. If you go this route, about all you should need to provide your CPA or tax professional is a copy of your financial statements. Your accountant may also ask you for copies of bank records. If you take credit cards or receive 1099s, your tax professional will also ask to see copies of those.

If your business finances are simple, you may be able keep your records on a spreadsheet. If you use this approach, group your expenses by logical categories so that your tax preparer will be able to know how to put them on the tax form.

Unresponsiveness

Many clients do not respond when their accountant tries to contact them. The reason the accountant is calling is either to find missing information or to clarify something that is not clear. Unresponsiveness increases the cost of preparing your return because it is difficult to work with missing information and it takes longer to prepare the return. In addition, every one of those phone calls and emails take time.

Change your habits!

Now that you know about these habits that cost you money, you can start changing your behavior.

Get organized!

Talk to your CPA or the professional that prepares your filing. He or she can tell you exactly what you need to do in order to simplify your tax filing and to make it less expensive to prepare your return. Take advantage of the checklists and organizers your accountant provides. Spend a little time reviewing your documents before you take them to your accountant.

Keep records throughout the year, and organize them so that they will be ready for your accountant. If you drive an automobile for work, get one of those auto record books and keep it. Your CPA may be able to provide you with an expense log. Keep your business and personal records separate.

Get help with your records.

It is worth your time to talk to your CPA or to a bookkeeper to learn how to set up your records. If you have a small business, seriously consider purchasing bookkeeping software. If you do, it is worth your while to ask your accountant or bookkeeper to help you set up your books. If you don’t want to organize your own records, or if they are too complex, then hire a bookkeeper. The cost of paying a bookkeeper to do your books throughout the year will be less than the cost of asking your accountant to do it a month before your taxes are due.

Return your calls! Respond to email!

When the CPA calls or emails, assume it is important and respond! If you do not return your calls or answer your email, then one contact becomes two or three or more. Your CPA will be able to complete your return faster and for less cost if you respond when he or she tries to contact you.

Understanding Your Business: Setting the Right Price

One of the more challenging things for small business owners to do is to set prices correctly. Figuring out what to charge for goods and services requires figuring out how to charge enough to cover expenses and make a profit while not charging so much that potential customers will refuse to pay. There are several theories about pricing. One theory that works with commodity type products says to charge a very low price and try to sell a lot. Another theory that works with specialty items or very high quality items is to charge a premium. Your approach will probably be somewhere in between those two approaches. Before you can do anything, however, you must know what it costs you to produce your product.

If you break your costs into parts, you will find that you have both fixed and variable costs. Fixed costs are the costs that you have before you begin selling anything. Variable costs are the costs of each product that you sell. If your business is a coffee shop, your fixed costs are rent, utilities, payroll, and the like. You will have those costs even if you sell no coffee or food. Your variable costs are what it costs you for coffee, food, and whatever else you sell. Fixed and variable costs behave differently as your sales increase. Variable costs per unit sold usually stay the same. If costs you a dollar to make a cup of coffee, put it in a cup, and then wash the cup when the customer is finished, then if you sell 100 cups of coffee your cost is $100. If you sell 500 cups, your cost will be $500. Fixed costs, on the other hand, get less expensive per unit as you sell more. If your monthly rent and utilities total $2,000 and you sell 1000 cups, your fixed cost per cup will be $2.00. Your cost per cup will drop to $1.00 if you double your sales. In this simplified example, if you 1000 cups of coffee in a month, you will have to charge $3.00 per cup to cover your variable cost of $1.00 plus your fixed cost per cup. If you sell 2000 cups, your price can drop to $2.00. Even though the variable cost remains the same, your fixed cost per cup is only $1.00.

The lesson is that your price must be high enough to cover your variable costs plus some portion of your fixed costs plus a reasonable profit.

Understanding Your Business: Budgets

One of the things that I help my clients understand is budgeting. Using a budget seems like something that should be easy. Unfortunately, many people have some misconceptions about budgets, and that makes using a budget harder than it needs to be. In this article, I will briefly explain some common types of budgets and address the budgeting myth that makes creating and using budgets difficult.

Let’s begin by answering the question, “What is a budget?” There are a lot of ways to answer this. The easiest answer is simply that a budget is a plan for resources. In a business setting, budgets are plans for income and expenses. However, budgets don’t have to be just about money. They can be a plan about any type of resource. A SCUBA diver, for example, will budget air for a dive by considering how much air is contained in a tank and how rapidly a diver uses the air. Farmers may develop water budgets that consider rainfall, humidity, how much moisture crops need, and how much water must be purchased for irrigation.

Many small business owners get along just fine without using budgets. Their businesses may be small enough or simple enough that they can keep track of everything without a budget. However, at some point, most businesses need to begin budgeting to be successful. Service businesses need to consider how many hours of service they can provide, and they need to manage their overhead. Manufacturing businesses need to track raw materials and job costs as well as sales so that they can be efficient. Businesses that resell goods need to be able to track inventory and sales. All businesses need to keep track of their cash, and growing businesses need to plan for capital purchases. If all of that seems complex, don’t worry. Once you understand budget basics, then the budget will make these things easier.

While it seems like there are many ways to create a budget, we will consider three simple types: 1.) Operating, 2.) Cash, and 3.) Capital. The next few paragraphs will summarize each type. I’ll provide more detail in later articles.

Operating Budget

An operating budget is a plan for obtaining revenue. and managing expenses. The most difficult part of preparing an operating budget is making accurate estimates of sales. I’ll spend an entire article describing how to build an operating budget later. For now, simply recognize that your sales drives both your income and your expenses. Begin by estimating what you will sell. From that you should be able to develop an estimate for your gross sales. Then figure out what it costs you to produce the goods or services that you sold. That is your costs of goods sold. Subtracting your cost of goods sold from your gross sales will leave you with gross profit. Note that the sales and cost of sales figures are typically variable expenses. The next item in this type of budget is going to be your general and administrative expenses. This includes items such as rent, equipment, office supplies, and similar items. The key to successful budgeting is to put in the effort to make accurate estimates for each category of expense. Another important point about operating budgets is that they are typically used over a single operating cycle. It is possible to create an operating budget that covers several years, however the out years in a multi-year budget are frequently unreliable.

Cash Budget

A cash budget is a close cousin to the operating budget. However, the intent of the budget is to help plan cash flow. Cash does not always track business activity in a firm. Business owners extend credit to good customers, and vendors often offer terms. Businesses also borrow and repay debt, and they purchase expensive capital items. Most business owners recognize that they need some sort of minimum amount of cash. The aim of a cash budget is to help manage cash flow so that the business can maintain the minimum desired amount of cash on hand. For each month in your budget, begin with your cash on hand. Then add your cash income. This is going to be equal to any cash sales. Remember that not all sales are cash sales. Some sales are credit sales. Add the current collections for credit sales to the cash sales number. Add any other cash from other sources. Next subtract all of your cash expenses. Remember that if you purchase goods or services on terms that you may not have paid cash. Use only cash expenses. Then subtract all your payments for previous expenses that are unpaid. The balance will be the cash available to your business.

Remember your minimum desired cash on hand? Compare your available cash to your desired minimum. If your available cash is less than your minimum, then you need to find a way to increase your cash. If the available cash is greater than your minimum, then you may want to pay down a line of credit or use your excess cash in some other productive manner.

Capital Budget

Businesses frequently need to make large purchases that cannot be made from operating funds. It is one thing to purchase office supplies or inexpensive office equipment. It is something else to purchase expensive equipment, furnish an office, or replace a company-owned automobile. Sometimes businesses can save and purchase the types of things. Sometimes businesses must borrow. In either case, smart business owners plan these purchases. Remember that the operating budget typically covered a single year and included operating expenses. A capital budget covers many years and includes expensive items that would normally be capitalized and depreciated. For example, most computers have a working lifespan of three to five years. A smart business owner would develop a plan for replacing the computers periodically. A commercial property owner might also develop a plan for HVAC replacements and roofing.

Budget Myths

The biggest myth about budgeting is that once the numbers are entered, the budget is fixed. Remember that a budget is based on estimates. As more information becomes available or as circumstances change, estimates can change too.

Another myth about budgeting is that variance or results different than what was planned is bad or reflects some sort of failure. That is not necessarily true. The problem with budget variances is when they cannot be explained. I’ll write more about this at a later time.

The most important things to know about budgets

A budget is a plan based on estimates. The most important reason for preparing a budget is that it forces you to think about your business and make assumptions about sales, revenues, and expenses. It also gives you a plan for the operating cycle.

A cash budget helps you keep track of your cash flow.

A capital budget is a tool that you can use to plan expensive purchases over a period of time in the future.

All budgets are based on estimates and information that was available at the time. Budgets can be dynamic and change as information becomes available and circumstances change.

Understanding Your Business: Keeping the Books II

I’m frequently asked why it is important for small businesses to keep their books in good order. Some of my clients run their businesses with nothing more than a checkbook and a notepad. If you are a small business owner and you can keep track of everything that way, great. However, businesses grow, and when they grow they tend to become more complex. Many business owners discover that the simple checkbook is no longer sufficient. Keeping track of receivables and payables and inventory becomes increasingly difficult with a notepad and a spreadsheet. As a business owner, you use many tools to manage and grow your business. Those tools might include advertising and marketing, staffing, and bookkeeping. Your business toolkit should grow as your business grows. Whatever stage of business you are in, you need to be able to keep track of your activities and summarize your results.

You need to keep books your books organized and produce financial statements for two reasons. The first reason is that you need them to manage your business. The three financial statements give you a complete picture of the financial health of your business.

An income statement summarizes your revenue and expenses. It is a picture of the activity that took place over time. Some people call this a profit and loss statement.
A balance sheet summarizes your assets and liabilities. The balance sheet is a snapshot of what you own and what you owe.
A statement of cash flows summarizes your sources and uses of cash. If you want to know if you made or spent cash in operations, investing in your business, or financing your business, the cash flow statement is the place to look. The statement of cash flows is very important if you are using accrual accounting.

The second reason is that you may need to provide financial statements to other people such as lenders or your tax preparer. If you want to borrow money, your lender will want to have some assurance that you will have enough profit and cash flow to cover the debt service and that you will ultimately be able to repay the loan. Your tax preparer will need to be able categorize all your transactions to be able to prepare your return. Your business may be small enough that your tax return does not require a balance sheet, but you will still have to summarize your revenue and expenses.

Here’s a sad but true story that makes the point. Several years ago, I had a client with a small manufacturing business. He produced limited runs of very high quality goods on contract. In the beginning, he was the only employee. He made the sales to customers. He purchased the raw materials and made the goods. He ran his entire business with just a checkbook and he kept invoices, receipts, and records in a shoebox. As time went by, he grew. He had enough volume with his suppliers that they began offering him trade credit. He began expanding and started adding customers, including some large accounts. Some of his newer accounts took longer to pay. He wasn’t worried about the slow pay, because his vendors were giving him terms, and he was making a lot of money. Unfortunately, he was still managing his business using a checkbook and a shoebox. By the time I met him, he had lost track of what was going on in his business. The slow pay by some of his accounts could have been managed, but he did not know how. He could not keep up with his payables and his vendors began demanding cash on delivery. He was running a cash basis business and trying to manage receivables and payables, but he did not have a way to account for them. He started writing checks to pay vendors so that they would stop complaining that he was past due, and then his checks bounced. When I asked why he did not hire a bookkeeper or at least purchase bookkeeping software and learn to keep his own books, he told me that it cost too much. It is true that he saved money by sticking to his checkbook and shoebox. But the money he saved was more than offset by the cost of losing control of what was happening in his business. Losing access to trade credit meant that he needed more cash to run his business. He had to turn away business because he could not always purchase raw materials. Not having a robust bookkeeping system meant that he could not keep track of his slow paying accounts and he was unable to do anything to speed up collections. Finally, once he started losing control of his checkbook, the fees for overdrawing his account quickly added up. To make matters even worse, while he may have avoided paying bookkeeping fees, before his tax preparer could prepare his tax returns, he had to turn the shoebox full of receipts and invoices and the checkbook and bank statements into a set of financial statements. In effect, the tax preparer did a year’s worth of bookkeeping in two weeks. It turned out that he paid for bookkeeping after all. Unfortunately, it was too late to do him any good.

This example is a cautionary tale. As your business grows more complex, so should your accounting processes. The business owner above managed just fine with his checkbook and shoebox until his business began to grow.

My colleagues in the accounting world have similar stories of small businesses that outgrew checkbook and shoebox accounting. Savvy business owners realize that the processes they use in their business need to grow along with their business. Whether you hire a bookkeeper or do your books yourself, as your business grows, make sure that your management toolkit grows as well. However you manage your books, keep them in good order and make sure that you can summarize your results.

Understanding Your Business: Keeping the Books I

One of the things that I enjoy doing as a CPA is helping business owners understand their books and bookkeeping. I’m going to begin posting a series of bookkeeping tips that past clients have found helpful. If you have a question about something, let me know. You are probably not the only person with the question, and after I help you, I may be able to add another tip.

If you have a business, you keep books. I know that some business owners run everything just using a checkbook and a notepad. Other business owners use spreadsheets. Still other business owners use some form of accounting software. How you manage your business is up to you. The important thing is that whatever approach you use, it allows you to keep track of what is happening in your business. Your record keeping system should help you figure out where your money comes from and where it is going. Since this article is about accounting, we’ll use the terms revenue and expense.

Before getting too far into this topic, it is probably a good idea to cover two simple concepts. The first is the accounting equation. It is easy to remember, and if you are a business owner, you know it already even if you don’t know what it is called.

Assets = Liabilities + Equity

Most businesses start when the owner invests money and property that he or she already has or borrows money. Then as the business begins operations it starts having revenues and expenses.

Assets = Liabilities + Equity + Revenues – Expenses

One of the secrets of accounting is that everything ties back to the accounting equation.

The second concept is the accounting cycle. Accountants like to organize things by creating arbitrary cycles. In business, these cycles are typically quarters and years. You may find it helpful to use some other period such as a week or a month. The accounting cycle is simply the steps that are used to organize and report financial activity within a business. The first step in the accounting cycle is to analyze and categorize a transaction. All that means is figuring out how to classify a financial activity. Was it a purchase? Was it a sale? Did the business borrow money? Depending on the complexity of your record keeping system, there could easily be eight, nine, or more steps. For our purposes, we’ll keep it simple. Adjusting entrees and closing temporary accounts are beyond the scope of this discussion.

Analyze and record transactions
Assign the entrees to accounts
Prepare financial statements

You probably have a few questions. The most common question is, “What is an account?” The easiest answer is that an account is a category for transactions of similar types. For example, accounts might include sales or expense, and they would group transactions by whether goods were sold to a customer in exchange for payment or were purchased from a vendor. Accounts also categorize “things” such as assets like inventory or supplies, or debt. Businesses try to have accounts that represent all major types of business activities. The accounts themselves are organized by type: Asset, Liability, Expense, Revenue, and Equity. The types should be familiar now that you know about the accounting equation. The listing of accounts by type is called the chart of accounts.

Now that you know about the accounting equation and the accounting cycle, and you have been introduced to the chart of accounts, it is time for the first two tips.

Your chart of accounts should look like your business.
Simple is better.

What does it mean to say that the chart of accounts should look like your business? It simply means that you should have accounts that match the types of transactions that you are likely to have. For example, all businesses need revenue and expense accounts. If you are a simple service business, you might only need your cash accounts, a service revenue account, and miscellaneous expense accounts. If you purchase goods for resale, then you need a purchases account and an inventory account as well. If you manufacture products, then you may need raw materials, work-in-process, and finished goods inventory accounts. If you are required to collect and remit sales taxes, then you may need a sales tax payable account. If your business has employees, then you will need accounts for payroll and payroll taxes.

This is not as confusing as it seems. When you start planning your bookkeeping or accounting system, first think about your business processes. Then build your system around what you actually do.

The second tip is that simple is better. Avoid the temptation to have lots of accounts. Many business owners start out with too many accounts. This is easy to do if you confuse products with accounts. In my business, I work with individuals, small businesses, and not-for-profits. The products I provide are accounting services, consulting, and tax preparation. It might be tempting to have an account for each type of product and each type of customer. That is nine sales accounts! If I were a very large accounting firm with lots of employees and thousands of customers, I might find it useful to be able to analyze my sales activity that way. As a small business, however, I do not need to do that. Having nine sales accounts would make my books more complex and not provide any useful information. Business owners also tend to make their expense accounts too complex. Consider office supplies. Most business owners have a single office supplies account. However, other business owners have separate accounts for paper, file folders, pens and pencils, and more. It’s possible that those business owners need that detail. It is more likely that they don’t. Whenever you add an account there is a tradeoff between making your books more complex and the benefit you receive from the extra account. Keep in mind that it is possible to have too few accounts. I once had a client that had three loans: a loan from a family member, a bank loan, and money that he loaned the business. The business owner lumped all three loans into a single loan account. To further complicate matters, payments were simply recorded as loan payments without regard to the principal and interest component.

Remember when you are setting up and managing your books, they are a tool for you. The only reason to do anything is that you want to be able to see what is going on within your business. Your books help you track what you purchase and sell. They help you see your sources and uses of cash, and they help you keep track of the investments you make in the business.

Whether you are just starting out and creating a set of books or you are reorganizing your books, remember:

Your books should look like your business.
Simple is better.

Gifts and Taxes

It seems simple enough. You give a gift or receive a gift. What about taxes? Do you have to pay taxes when you receive a gift? What if it is a lot of money? Do you pay taxes if you give a gift?

Before answering these questions, let’s figure out what qualifies as a gift. The IRS says:

The gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return. The tax applies whether the donor intends the transfer to be a gift or not.

The gift tax applies to the transfer by gift of any property. You make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.

Do you pay tax if you receive a gift?

Generally, no. Taxes are paid by the person giving the gift.

Do you pay taxes if you give a gift?

The answer to this question depends on the amount of the gift. The annual exclusion for 2014, 2015, 2016 and 2017 is $14,000. This amount is per individual per gift. As an example, if two parents wish to give a gift to their two children, then they can give each child $28,000 (2 X $14,000.) If the gifts are greater than the annual exclusion amount, then gift tax may apply. Taxpayers should file Form 709.

Still confused? See the link below for answers from the IRS, and contact your CPA or tax professional.

IRS Frequently Asked Questions on Gift Taxes

What is income?

It is tax time, and that means that it is time for me to start answering client questions about income. Generally speaking, if you received money, property, or services, you have income. Examples of income include wages and fringe benefits, investment income such as interest, dividends, or capital gains, business income, and income from bartering. In some cases, your income may be documented. For example, if you have wages, then your employer will give you a W-2. Interest and dividends are reported on 1099s. If you are self-employed you may receive 1099-MISCs if the amounts paid you by clients are above a certain amount.

Not all income is documented.

If you run a business, it is up to you to keep track of revenues and expenses. If you are self-employed, some of your income will come from clients that will not be required to send you a 1099. Please avoid the temptation to forget to include this undocumented income when you are getting your books ready for filing your tax returns. The IRS is pretty good at comparing expenses to revenues and figuring out when income is not reported. If you are caught you will end up paying the taxes plus penalties and interest.

Not everything is taxable.

Income can either be taxable or nontaxable. For example, if you receive a gift, that is not normally taxable income. Keep in mind that depending on the size of the gift, the giver may have to pay gift tax. Some income such as interest from some municipal bonds may also be nontaxable. Nontaxable interest, however should be reported on a tax return.

Don’t forget your basis!

If you sell investments or your home, you will receive a Form 1099 for the gross proceeds. Be sure to figure out your cost basis, or what you paid. For example, if you have a stock portfolio, and you sell stocks worth $1,000 then you will receive a 1099 for that amount. However, your net income is the proceeds less whatever you paid for the stock. Don’t forget any reinvested dividends. The same thing applies if you sell your home. Depending on the circumstances, you may be able to exclude a lot of the gain. Be sure to talk to your tax pro if you have sold a home. If you complete your own tax return, read the instructions carefully.

Do you owe Use Tax?

We all know about sales tax. It is a tax paid whenever we purchase something. The tax is some percentage of the purchase price. Did you know there is another tax called use tax? Use tax applies whenever you buy, lease, or rent items without paying sales taxes. The tax is based on the price, and the rate is the same as the sales tax rate.

Did you make Internet purchases or buy something from an out-of-state mail order vendor? You may owe use tax. According to Minnesota Revenue:

The majority of businesses have a use tax liability.
The most frequent assessments made in audits involve unreported use tax.

The fact sheets below from Minnesota Revenue provide more information.