PEMBROKE, Mass. — I’ve been preparing tax returns professionally for more than 20 years, and this year, I’d thought I’d present some misconceptions that I’ve encountered. Of all people, you would think successful businessmen would understand their taxes. Often, their beliefs do not stand up to scrutiny, as you will soon see.
‘FILING A HOME OFFICE RAISES A RED FLAG’
Many Laundromat operators are afraid to set up a home office because they don’t want to confuse their home with business. Nothing could be further from the truth. A home office deduction is an expense that is comprised of a proportionate portion of housing costs—mortgage, property taxes, utilities, repairs, improvements and depreciation. The only requirement is that the space is used exclusively and regularly for doing administrative chores.
If you do some work at home, then you should set aside space—a desk and file cabinet, say—to do the work, and do it regularly there and reserve the space for your business work. That’s a legitimate home office. Even if you have an office at work, you can still have a home office at home, and in turn, receive a home office deduction.
‘THE IRS DOESN’T AUDIT SMALL COMPANIES BECAUSE IT ISN’T WORTH THEIR WHILE’
In fact, the IRS audits all kinds of situations, from solo practitioners to large corporations.
Its reasons for auditing are varied: because the firm’s results are vastly different from past years, because the company is out of line with companies in the same industry, because there’s a gross disparity between lifestyle living and business performance; because there’s a big push on that industry.
In addition, the IRS also undertakes a number of random audits.
‘SO MANY OF THE RICH AVOID PAYING TAXES, SO WHY SHOULDN’T I?’
Before 1986, this was true. There was a provision in the tax code that said that passive loss could reduce income to zero. Many wealthy people invested in schemes in which they were passive investors. For example, a person invests in real estate that puts out huge paper losses during the first several years. Result: the business owner’s $200,000 income is offset by $200,000 in losses, resulting in zero tax liability. But President Ronald Reagan created the Income Tax Reform Act of 1986, in which he limited passive losses to $25,000. In one fell swoop, the greatest personal income tax loophole was destroyed.
Today, there is only one loophole left: a venture capital principal pays federal taxes at 15% maximum. For the high-income taxpayer, there are automatic reductions in credits as income rises. In addition, AMT (alternative minimum tax), an autonomous tax system, is superimposed above the conventional system to make sure the taxpayer pays at the 26% tax rate for a part of his income. As a result, most rich people, with incomes at $300,000, pay 30% federal, state and Social Security taxes. Wealthy families making $500,000 pay 35% taxes. To compare, a family in the $100,000 income range averages 18% to 20%.
One might argue that the wealthy can afford to pay more than 35%, or that 20% is a far more onerous burden on the $100,000 income earner. That subject is open for debate. But one can no longer say that the rich don’t pay a lot of taxes.
Have a good tax season.
Miss Part 1? You can read it HERE.