Business or Hobby? Why Does it Matter?

Among the many challenges that sole proprietors must face is dealing with the IRS. Of course, most profitable small businesses find that their primary IRS concern is dealing with the tax burden. However, there is a chance that IRS can seek to prove that an unprofitable enterprise doesn't even qualify as a business. This is especially true when the business in question contains a significant element of personal enjoyment, as in the case of artists, race car drivers, or animal breeders.

If a business venture does not show a profit in three out of five years, the IRS could take the position that the activity is not being conducted on a “for-profit” basis. Why would they do this? Because while losses incurred by businesses are deductible, losses incurred in the pursuit of a hobby are not.

If a business' records show that it has incurred losses for several consecutive years, it could potentially be at risk of the IRS challenging its profit motive so they can disallow these losses. If the IRS reclassifies a business as a hobby, any losses will be limited to the gross income for that activity for each year. Any excess expenses will be treated as personal items and disallowed, leaving the owner owing taxes plus interest and penalties on any amounts disallowed.

Obviously, an owner would want their business to be able to deduct all of its expenses each year. However, if that business is not profitable for three of five years and the IRS challenges its losses as hobby losses, the taxpayer would have to prove under the “facts and circumstances” test that they are at least attempting to build a profitable business. The facts and circumstances test looks at several factors. Some of these are:

--the manner in which the activity is conducted
--the expertise of taxpayer in the area
--the amount of time and effort spent carrying out the activity
--expectation of future growth
--the success of the taxpayer in other activities
--historical profits or losses of the activity
--the overall financial status of the taxpayer (does he depend on this income?)
--any elements of personal pleasure derived from the activity

The IRS makes its decision on a case-by-case basis, and there are no set rules for determining whether an activity is carried on for-profit or is a hobby. Some things an owner can do to support their position of carrying on a “for-profit” business are:

--keep thorough, business-like books and records
--use a separate checking account and credit cards for the business
--keep a log of personal use of business assets
--carry applicable professional insurance for your business
--advertise the business in trade journals or local sources

Hopefully, all of your ventures are profitable. In the event that they are not, following these guidelines will ensure that you are able to properly deduct all of your business losses.

--Dan Musick is the Tax Services partner for Cook & Associates, a full-service public accounting firm with offices in San Marcos and San Antonio, TX

VACATIONS – LIKE MILK, THEY DO A BODY GOOD

Shortest vacations in the industrial world? Check. Regularly work over 40 hours per week? Check. High blood pressure? Check. Think there might be a correlation here?

U.S. employees work more hours and get fewer vacations than many other countries. Such strenuous work activity has led to an increase in stress and a decline in health in the general U.S. population.

According to Expedia, U.S. employees get an average of 14 vacation days per year. This is less than half of most European employees, where employees get anywhere between 26 and 37 days per year. Yes, the U.S. is the leader in productivity. However, France maintains a hold on 2nd while only working 35 hour work weeks and getting 37 vacation days per year! Maybe we should re-think the way we do business.

Need 5 good reasons to take a vacation this year? I’ll give you 10.

1. They help you recharge, rejuvenate and avoid burnout.

2. Vacations can inspire you and provide new ideas for the workplace.

3. You are generally more organized and focused in the weeks leading up to a vacation. Prioritizing is a key aspect of this time period.

4. Vacations can reduce stress, which can reduce many health problems such as high blood pressure.

5. Vacations = more sleep = improved clarity and performance.

6. They promote bonding time with family and friends.

7. You can step back and think about the big picture. This can help re-focus the work lens.

8. Changing the pace and place is good for the brain.

9. Seeing the world can expand your horizons and allow you to consider different approaches.

10. Errors, omissions, and even fraud can be detected when an employee takes time off. This is good for internal control purposes and can improve the health of the business.

And one more for the road: When you’re lying on your death bed, you’re not going to say “Man, I wish I had spent more time at the office”.

--LeAnn Carlson is the Audit Manager for Cook & Associates, a full service public accounting firm offering services from offices in San Marcos and San Antonio, TX.

WHERE ARE THE WOMEN LEADERS?

I sat down with my first cup of coffee of the day with the idea of catching up on the last few days reading. It seems like the longer that I am in public accounting the more it changes. The more it changes, the greater the reading requirement becomes.

In the November 1 edition of Accounting Today, the major headline was “Where are the women leaders (in public accounting firms)?” As I read the article written by Liz Gold, I found myself nodding with approval of the article’s comments. I also found myself nodding with disapproval.

If you read the Wall Street Journal, you will note that there are a number of Fortune 500 companies with women as their CEOs. Many nations now have women as their heads of state. So why are women scaling those very high walls on a more frequent basis, while their counter parts in public accounting can’t seem to get over the backyard fence?

The AT article reports that 55 percent of new hires in CPA firms are female, but the number of women partners in CPA firms hovers around 25 percent.

The article offered some insights which you may or may not agree with.

One point offered by Gale Crosley, the co-coordinator of the Forum for Women in Accounting, was: “Women are taught to be responders, not initiators…business protocol require that if you are going to rise to the top of the accounting profession, you’ve got to be an initiator. Being an initiator, having self-confidence and being fearless around self promotion are all traits necessary to succeed in the profession.”

A second point was offered by Rita Keller: “I don’t think women want partner bad enough.” She stated (and I paraphrase) that women make good money at the manager level, with prestigious titles, and found that CPA firms are willing to work around their family schedules. She states that life has been good to women in public accounting and is puzzled at why women would complain.

A final point was offered by L. Nakarmura, a former KPMG partner, now the managing partner of a large local firm in California: “They (women) knew that to be the parent they wanted to be, they couldn’t be the employee they expected of themselves. So they chose to leave the profession because they couldn’t find a way to balance home success and work success.”

My money is on the last of the three points. Public accounting is extremely demanding. The general public thinks that we work hard from January through April 15 and then play the rest of year. In fact, tax filings occur throughout the year. Accounting services, audit services, financial consulting and software implementation are year-round concerns. Every month of the year has both State and Federal deadlines. A standard work week for most public accountants is between 50 and 60 hours. Burn out and alcoholism are major issues in the profession.

I have been in this business for about 26 years. I have found women to be bright and most capable. I have found them to be motivated and initiators of the first level. I have found their management skills to be equal of men’s although their style is different (women want to talk things to death before making a decision).

I also have observed that the family is a higher priority than the job for female accountants. Frankly, I consider that a good thing. So, if you are a potential employer, know that there are some incredible female talents out there. But also recognize that their kids will always come first and you must be flexible on this issue. It seems like a small price to pay for top quality talent.

--Steve Cook is the managing shareholder of Cook and Associates, PLLC, a certified public accounting firm with offices in San Antonio and San Marcos, Texas.

Deadlines, deadlines......

In the CPA world, there's nothing like a tax deadline. Many grey hairs, ulcers, and headaches have been born of the rush leading up to April 15 or October 15 (and in the old days, August 15). Clients who wait until the last minute to deliver their information, other preparers who wait until the last minute to prepare forms that you need for one of your clients, and other non-tax work that just can't wait all contribute to the hectic nature of the filing deadline. Overall, a non-scientific review of our case load reveals that almost 1/2 of the returns that we prepare in a given year are filed within 10 days of a deadline.

April 15 is the most well-known deadline, but for CPAs it's not actually the most stressful. That "honor" is reserved for October 15. Why? Because if the work isn't done by April 15, you can always file an extension. However, no extensions are available for October 15....it's truly a "drop dead" due date. We may go for several months during the summer and only be able to complete a couple dozen extended returns, only to have thirty to forty returns come in after October 1. Clients know that if they don't file by October 15, penalties and interest are sure to follow.

As a professional service provider, you never want to tell a paying client that you can't meet a deadline for them - especially in this economy where each client is vital. So while the lay person might say "just tell them you can't do it" or my wife's frequent response, "Did you laugh at them", the CPA's response is to roll up their sleeves, put on another pot of coffee, and prepare for a long evening at the office. That guy who brings you four filing boxes full of loose receipts on October 14 at closing time can make you want to rethink your approach sometimes, though.

At the end of the day, everyone gets taken care of, and we've survived another tough filing deadline. It's time now to spend the rest of the year dealing with "troubleshooting", doing tax estimates for the current year, and catching up on continuing education. Once January 1 hits, it's back to tax season and the countdown officially begins toward yet another deadline.

--Dan Musick is the Tax Services Partner for Cook & Associates, a full-service public accounting firm offering tax, auditing, accounting, and payroll services from offices in San Marcos and San Antonio, TX.

YES DOROTHY – THERE ARE STILL GOOD SAMARITAINS

A couple of weeks ago, I was in the process of losing my mind. It had been an absolutely horrible week. If it could go wrong, it did go wrong. The apex of the week occurred at my favorite Valero station.

With the red gas light screaming at me, I pulled in for gas. My head was pounding from the weeks activities. I pulled my credit card out, swiped it, and filled up my tank. When the pump “bonged”, I put the gas cap on and drove off. Guess what? My wallet and all its contents were still on the trunk of my car!

The next day, I was driving to Austin for a meeting. I was in dire need of coffee. I pulled into Starbucks, reached for my wallet and found nothing but air. I had absolutely no idea where my wallet was. I racked my ibuprofen- and caffeine-stimulated brain, but to no avail.

I had just sat down at the meeting when the office texted me that someone had found my wallet! In what has to qualify as a miracle these days, he had found it and called to return it – intact!

Yes Dorothy, there are still good Samaritans out there. Thanks again, Mr. Ray Soto!

--Steve Cook is managing shareholder at Cook and Associates, PLLC; a CPA firm with offices located in San Antonio and San Marcos.

FDIC INSURANCE – ARE YOU AS PROTECTED AS YOU THINK?

I recently attended a continuing education seminar discussing FDIC. Boring, you say? Not quite. It piqued my interest just enough to have me returning to the office and (you guessed it) “googling” FDIC.

The first site to pop up on my search was http://www.myfdicinsurance.gov/. The site prominently displays the following picture:

What exactly does FDIC insurance entail? If you’re like many Americans, you may have been under some common misconceptions. Here’s what you need to know:

FDIC stands for Federal Deposit Insurance Corporation. It is an independent agency of the federal government that was created in 1933 to insure deposits in banks and thrift institutions. Interestingly enough, no depositor has lost a single penny of insured funds since the program was created.

Misconception #1: The FDIC insurance limit is $100,000.
Good news. The limit was upped to $250,000. This means that for each “ownership category” (single, joint, revocable trust, retirement account, etc.), you are insured up to the basic limit of $250,000. So, if you have deposits in three of the categories, you qualify for up to $750,000 in coverage.

Misconception #2: Having multiple bank accounts increases your coverage.
Dividing money into multiple bank accounts does NOT increase your coverage. For example, let’s say that Sue has a checking account and a savings account at the same bank. Both accounts are in her name only. She has $150,000 in checking and $200,000 in savings. Even though she has $350,000 in the bank, she is only insured up to $250,000. Keep in mind, if Sue instead had a single account with $150,000 and a joint account with $500,000 (shared with husband Joe), Sue would be insured for $400,000 ($150,000 + ½ joint account up to $250,000). Sue could also increase her coverage by having accounts at different banks, even if they are in the same account class.

Misconception #3: The FDIC does not pay out the insurance in a timely manner.
Federal law requires the FDIC to pay deposit insurance as soon as possible. Often, this means making the funds available on the first business day after the bank is closed. In addition, depositors may also be able to recover some or all of the uninsured portion of deposits, depending on how much the FDIC recoups from selling the bank’s assets. Unlike insured recovery, uninsured recovery can take up to two years.

As the picture says, “Don’t bank on your mattress”. Structure your accounts properly and get a good night’s rest knowing your money is federally insured.

--LeAnn Carlson is the Audit Manager for Cook & Associates, a full-service public accounting firm operating from offices in San Marcos and San Antonio, TX

GDP: The Nation's Report Card

Why do I care about the GDP?

As my blog readers have noticed, from time to time I have railed about the dangers of runaway government spending. I am not an isolationist. I am a moderate. I believe that debt - in moderation where there is the ability to repay - is a sound business strategy. This strategy works in government as well as business.

The problem arises when the strategy is abused. There are some telling signs that our friends in Washington are heading past moderation. Economists consider the Gross Domestic Product (GDP) and its relationship to other countries’ GDPs to be our “economic report card”. In its simplest terms, the GDP measures the output of a country’s goods and services. In the past, the United States raced ahead of the world in GDP. Relative to the rest of the world, we enjoyed lower interest rates, greater purchasing power, and lower costs of goods and services.

Recent report cards haven’t been so good. The U.S. has fallen behind both Japan and Germany in GDP. What is most interesting is that both Japan and Germany have experienced deeper drops in GDP than the U.S. So what does this really mean?

First, it is a not so subtle reminder that we live and operate in a global market place. This global market affects the costs of many the products that we use in our daily lives. The computer that this blog is written on is “Made in USA”. Well, sort of. The chips are engineered and created in the U.S. but are manufactured overseas. The boards and drives are created in the U.S. but are manufactured overseas. It is “Made in USA” only because HP is located in the U.S. Most of the products that we use in our daily lives follow similar paths. The strength of the dollar is tied directly to the GDP. This affects our purchasing power and ultimately the end cost (consumer cost) to us.

Second, the GDP affects our cost of money. The U.S. is currently the recipient of billions of dollars in overseas investment capital. These overseas countries and investors buy the bonds and money instruments that the US Government issues to run the day to day operations of our government. As the strength of the GDP declines versus the rest of the industrial world, the value of the dollar decreases. As the value of the dollar declines, the desirability of U.S. money funds decreases. When U.S. money funds become less desirable, the government is forced to pay higher interest rates to attract investors.

Why is this so important to your small business? Even the smallest “mom and pop” businesses are connected somewhere to companies that are caught in the global marketplace. Let’s say for example that you run a corner Taco Stand. Your suppliers are Sysco Foods, H.E.B., Wal-Mart, etc. All of these giants purchase their products in a global market. No matter how small you may think you are, you are never outside of the “global market place”. The GDP report card affects you.

Now let me apply this thought process to the US government. The government has a relatively fixed amount of revenues annually. If expenses exceed revenues (called deficit spending), the government goes to the market and borrows money. When the dollar is weak, the U.S. government must pay a higher interest rate. Since revenues are fixed, the increased cost of debt service (interest) leaves less money to fund other programs. If you can’t cut costs, what do you have to do? Raise revenue – and to a government, that means increasing taxes on its citizenry.

Think about this. In 2000, the amount of our GDP needed to pay the interest on the nation’s debt was 2%. In 2010 it is expected to be a similar amount. Under current revenue and expenditure rates, the 2020 rate is projected to increase to 3%. By 2050, the rate is expected to be 5%. These are huge increases when you consider that we are talking about interest on trillions of dollars in debt.

In the long run, we have to manage our debt – both in our personal lives and in our government.

--Steve Cook is managing shareholder for cook and Associates, PLLC a CPA firm with offices located in San Antonio and San Marcos, Texas.

Facts about our tax system

If you think our tax code is overly complicated, you're not alone. And you're probably right. Consider the following not-so-random facts:

--Our original tax code, published in 1913, contained 11,400 words. Today the tax code contains over 7 million words. By comparison, the Bible only contains 773,000 words.

--When the Sixteenth Amendment created the income tax, the lowest tax bracket was 1% and the top tax bracket was 7%. Today, our lowest bracket is 10% and the highest is 35%.

--There are about 490 different tax forms in the IRS' library.

--Our "easiest" tax form, the 1040EZ, comes with an instruction booklet that is 33 pages long.

--The IRS sends out 8 billion pages of forms and instructions each year. If laid end to end, they would stretch 28 times around the earth.

--The Cato Institue estimates that taxpayers spend 6.4 billion hours each year working on their tax returns. That's the equivalent of a company having 3 million full-time employees.

--General Electric Co. electronically filed a tax return containing 24,000 pages. If this return had been printed, it would be over eight feet tall!

--The IRS has 114,000 employees - five times as many as the FBI and an operating budget just for payroll of approximately $10 billion.

--It costs the IRS $2.45 to collect $100 in taxes.

--The government spends an estimated $2 billion per year on federal tax compliance. This is more than it costs to produce every vehicle made in the United States in a year.

I am not necessarily an advocate for a flat tax, but given these facts, it's clear that something needs to change. Besides the fact that there is too much pork in Washington, our current tax system costs our government - and by extension, our citizens) too much to administer.

--Dan Musick is the Tax Services partner with Cook & Associates, a full-service public accounting firm with offices in San Marcos and San Antonio, TX