If you missed last Saturday’s webinar “IRS Tax Secrets for Online Business”, you can listen to the replay at http://www.OnlineBizTaxSecrets.com.

Here’s one of the questions we didn’t get a chance to answer:

Question:

Could we pay our younger children modeling fees if we use them for advertising?

Answer:

The answer on most of these questions will be “It depends.” In this case, there are a lot of items to consider:

(1) Is there a real business?
(2) Is there a real business purpose? In other words, do photos of your younger children help your business in advertising?
(3) ONLY if you answered yes to the above two questions, continue on to the three rules we use for hiring dependents.

Rule #1: You need to have a written description of the work done.

Rule #2: You need to pay a fair price.

Rule #3: You need a receipt or time card (if a regular employee) proving the work was done.

Can you take the deduction? Maybe. Just make sure you follow the rules.

This past Saturday, Megan and I did a webinar “IRS Tax Secrets for Online Businesses.” You can listen to a replay at http://www.OnlineBizTaxSecrets.com if you missed it.

We couldn’t get to all of the questions during the webinar, and so, as promised here is one of the questions and the response.

Q: On “nexus” what if you are working with and MLM, who is responsible for the tax? me, as an independent distributor or the MLM company?

Answer: Without a doubt, nexus will be one of the biggest issues for all businesses, and especially Internet-based businesses. In the case of MLM (aka multi-level marketing companies, direct selling companies and independent business opportunities) companies, at this point, there is no nexus issue. However, California has recently asked all California (CA) residents in an MLM to provide the name and addresses of their “uplines” (people who had signed them up). Amway is fighting this.

There is a concern that CA may intend to use this information to then claim nexus on residents in other states. Since these other state’s residents make money because some of their downline is in CA, then CA will make a claim that they owe CA income tax. Or at least that’s the reason we think CA is trying to collect this information.

At least so far, though, no state has been able to successfully claim nexus due to MLM downlines in another state. If there is a product that is sold that should have sales tax attaching, the main company will probably be withholding sales tax. This is something you do need to check directly with your company, though.

Richard and I moved to Baja California full time in 2009. We’d taken a major economic hit in 2008 and thought it was time to just semi-retire at the beach.  We spent a lot of time traveling, gardening, hanging out at the beach and a little bit of time working.  Then things changed, this time for the better, at least economically.

In 2008/2009, things changed and we reacted. Then in 2012, things changed again. One was the slow and steady growth of our full service tax firm, US TaxAid Services. The other was a crazy serendipitous business that started because my partner Megan and I used the wrong URL address. It’s an international business, with all of our sales outside the US, so it’s taken a lot of research to figure out how to do this.

With the growing company and the crazy growing company, our income is up. That means more options. And a company that goes through rapid growth means more hands on time is needed for systems, hiring and technology.  So, we need to move back to the US.

Our businesses are virtual so we can work and live and anywhere there is good internet. Our first stop was Austin, TX.  We spent hours in online research so we knew the area and knew what was happening with real estate prices. Then, we spent hours in key areas we’d identified. After all the hours spent, we knew what was a good deal for us and we made an offer, with a short window. We actually surprised the sellers because we were so certain in our offer. In the end, the deal fell apart, I think largely because the seller and especially his agent couldn’t keep up. Our offer never wavered and it made them nervous that we were so certain and acted so rapidly.

We went back and forth on whether it was worth it to do another trip to Austin to go through the process again. (I love DolfdeRoos’s rule of thumb:  Look at 100 houses, offer on 10, buy 1. That is so close to what we do.)

We instead went to my old hometown of Reno, NV. There are some interesting developments in Nevada that have created a very small market of houses to buy with low rents.  We expect that to flipflop in the next 18 months. Meanwhile, we found a deal with an experienced real estate investor seller. We did a deal quickly and are closing in less than 30 days. (Actually 2 weeks now)

The reason I’m telling this story is that some people looking from the outside in may think we’ve acted without thinking and are jumping from one thing to another.  Texas or Nevada? That’s kind of a crazy jump. The fact is we did a lot of research first. We put in the time first so we can act fast and with clear focus when it’s ready.

That’s how we’ve been able to turn our finances around so quickly. From the bottom at the end of 2008, we were financially free August 22, 2010. And we’re moving up from there.

For us, the answer is research carefully, be really clear about our goals and then act decisively.

I know decisive decisions and actions can be hard for some people. It’s a habit just like any other habit. The first few times you try something new, it will feel uncomfortable. As you get more experienced, it’s easier. The habit of making instant decisions for your business may seem impulsive and it is, only if you haven’t done your homework first. If you dither back and forth, not making any decision you basically derail any chance of ever having a successful business.  People won’t wait for you.

I experienced it again when Megan and I did a webinar this past weekend. I made a special offer, a REALLY good offer, for 5 people for a strategy. There were 2 or 3 people who jumped on it right away. They had signed up because they knew it was a good deal, they knew what they needed and they trusted me and our process.  But then it stopped. Some people needed a lot more information. And sure, we’ll provide it.

And there are still two spots left (at least as of Monday, when I’m writing this blog post) for the special deal at http://www.OnlineBizTaxSecrets.com. But I bet those spots end up being gone before the people with all of the questions get those questions answered.

Do your homework FIRST, so you know a deal when you spot them. The good deals never wait.  That’s how we’ve been able to grow back so quickly. Homework and decisive action – it’s a powerful feeling to be in control.

Would you rather have a half million dollar company or a million dollar company? If you answered, “It depends”, then you get to go to the front of the class.

Usually when you hear the term “million dollar company”, “multi-million dollar company” or the like, it refers to the gross sales of the company. So a half million dollar company gets $500,000 in gross sales per year. A million dollar company gets $1,000,000 in gross sales per year. Knowing that, which company do you want?

Did you say, “It depends?”

You still don’t have enough information to make that decision. That’s because you haven’t yet taken into account your costs. How much does every sale cost you? What kind of overhead costs do you have?

Typically those two types of expenses are called “direct” or “cost of goods” and “indirect” or “G & A” costs. The first group, cost of goods is directly related to the sale. So, if you sell a shovel, what is your cost of the shovel? If your janitorial company gets paid to clean a house, what is the cost of labor that went into cleaning the house?

The sales amount less the cost of goods gives you the gross profit. Gross profit numbers will vary wildly depending on the type of business you have. Once you have good monthly financial statements, you can compare your gross profit percentage to other months and to other similar businesses. In that way, you can see how efficient you are at fulfilling on the product or service.

The second group of expenses are your indirect, G & A or general & administrative costs. The G & A is comprised of all of the overhead your business has. If you don’t sell a single solitary shovel, you’ll still have to pay the rent. You may not have any cost of goods, but you still have G & A costs. G & A costs can be the hidden enemy of a business in growth mode. You may be tempted to gear up too soon and thus have a big jump in G & A. G & A has a loose relationship with the sales number, but it’s not as closely aligned as cost of goods.

Now, let’s ask the same question, with more information. Which would you rather have: A company that has $500,000 in sales with a net income of 80% or a company that has $1,000,000 in sales with a net income of 40%.

You may quickly pull out a calculator to verify, but sure enough, the net income is the same number. If this is all the information you have, it’s usually a better plan to go with the smaller sized company. There is more efficiency here If you could grow it to a million dollar in sales company with the same profit percentage, that would be a big difference.

But you still don’t have enough information to make an informed decision. We haven’t talked about how much money you have to put in the business. If the half million dollar in sales company took a half million dollars to get started, it would have a much higher capital requirement than the million dollar company that took only $10,00 to get started.

The return on investment is much better now with the million dollar company.

And one more thing to consider, especially if you have a closely held company where you do most of the work. Are you factoring in the value for your time? Or, looking at it the other way, have you accounted for all of the ‘cost of living’ type expenses that a non-owner/employee would not have?

Once you have all of that information, you can really assess how well your business is doing. And once you know how well you’re doing, you’ll know what you need to do more of, and what you need to do less of. Without that kind of analysis, all you’re doing is hoping you’re getting it right.

Watching your numbers, and interpreting the results will help you create a sustainable business that has true asset value.

Got a question? Here’s how you can get your questions answered: http://www.ustaxaid.com/got-a-tax-question/

We recently received a question about bringing a partner into an LLC. My partner, Megan Hughes, answered the question about how much or little you can give to an LLC and still have a legitimate multi-owner LLC. You can go here to

http://www.smartbusinessincorporation.com/blog/how-much-or-little-can-an-llc-member-own/

It never fails that I get a new tax client in late fall who hasn’t been paying attention to his business. Or rather, he’s been so busy with his business that he didn’t pat attention to his growing tax issues.

If you have a business that is taxed as a Sole Proprietorship either because you don’t have a business structure or because you are a single member LLC and didn’t properly elect a structure, you’re going to pay more tax. The S Corporation is usually the best structure. If you have an LLC, you can elect S Corporation, but there is a time limit.

In this article by Megan Hughes (in answer to a question we received), she answers how you can make a late S-Corporation election.

http://www.smartbusinessincorporation.com/blog/how-to-make-a-late-s-corporation-election/

We continue to get a lot of questions about real estate professional status. If you have a question, please go to http://www.ustaxaid.com/got-a-tax-question/ to find out how you can get an answer.

Here is a question we recently received:

“My questions:
1. - For tax purpose, if we file the LLC as a business, not a single member entity, in order to be considered RE professional, do each of us need to get the professional status with 750 hours of RE, or only 1 of us? (My husband has a full time job as Professional Civil Engineer. )
2. - If I and my Husband want to file joint tax return with flow-through taxation for the LLC, how do they consider my Husband’s income from the LLC if he’s not a R.E. Professional? (Currently we’re filing tax returns under his name, since I’m a homemaker.)
3. - How will this LLC Partnership affect our daughter’s tax return, who also has a full time job?
4. - Finally, how bad it would be for us, if we file the LLC just 2 of us, as husband & wife - which would be a “single member” LLC in CA?”

Answer:

Let’s start with the question of the LLC (limited liability company). You live in a community property state, which means a married couple is considered a single member entity. You can jump through some hoops and turn it into another type of structure (S Corporation, Partnership, C Corporation), but the default will be either to report on Schedule C if it’s an active business or Schedule E if you’re holding real estate as an investment.

I’m guessing from what you wrote that you have some real estate rentals. Those would report on a Schedule E, as part of your Form 1040.

There are three tests for the Real Estate Professional status. Please see yesterday’s blog entry with more detail on these.

For you, I would have one additional concern. You mentioned that your husband worked as a Civil Engineer. Typically, this would be a real estate activity, but ONLY if he owns part of the company. If he’s just an employee, the hours spent as an engineer do not count toward Real Estate Professional status.

It sounded like you might be trying to combine your hours together. You can not do that, only one of you needs to qualify with the 750 hours/more hours than any other business test, but ONLY one of you CAN qualify. You can’t combine hours.

Please note the comments yesterday about the LLC. You want to have a manager-managed LLC with the real estate professional named as the manager.

We had a lively discussion on business structures on this past Saturday’s webinar. If you missed it, you can catch up on this and other archived webinars at: http://www.USTaxAid.com/insiders-club/

Here’s one of the questions we weren’t able to get to in the allotted time.

“I am a realtor, I have my rental properties set up as series LLC. I would like to begin flipping properties. Can I consider the flipping as a “hobby” instead of setting up an “S” corp?”

We talked about a wide range of topics, including the IRS claiming some businesses with losses were hobbies and the way to use a Series LLC in a business to save costs and protect assets.

That’s what led to the confusion and the question from this attendee.

If you have a business with a loss, you want to make sure you get the tax benefit of the loss. If you have income, the IRS is going to make sure you have business status so you pay both income tax plus self-employment tax. That’s why we normally want businesses to be either an LLC taxed as an S Corporation or formed as an S Corporation. S Corps do not have pay self-employment tax.

You also will want to hold your real estate agent/broker business within an LLC taxed as an S Corp or as an S Corp. I wouldn’t suggest putting both together because if something happened with one business, it could impact the assets of the other business.

Since you have a Series LLC, it won’t cost you much to establish another cell. Depending on the state in which it was formed, you probably won’t have to register the cells so there is no ongoing cost.

My suggestion would be to get a cell set up and elected as an S Corp before you start buying and flipping property. You’ll pay less tax and protect your assets right from the start.

We recently received this question regarding Real Estate Professional status for an ongoing business.

“I formed an LLC with a partner in 2002. The business is involved with real estate (acquire land and develop, acquire existing building fixed up for sale or rent). However, the other partner opted out in 2004 and the business became a “Single member, LLC” with a Single asset on a large acre land. I am in the process of sub-division of the large land to build at least 3 single family homes on it. Mean time the existing commercial property on the land is rented out. I am fully involved in the activities of the property of the land. I make all management decisions, necessary repairs, court appearances if necessary, work with the banks that hold both first and second lien on the investment. I spend over 750 hours dealing with the affairs of this property which qualifies me as a “Real estate Professional” per IRS definition.

Recently, I have been selected for an IRS audit. I substantiated all the line item expenses on my schedule ‘C” for the business as was requested. However, the revenue agent is attempting to proof that this business is a “Passive Activity”. Is he correct? I do not agree with his assessment, please advise.”

Answer: Unfortunately, there is much more to legally taking the Real Estate Professional designation. There are actually three tests involved.

Test #1: Do you spend 750 hours AND more hours in qualifying real estate activities than in any other business?

The activity itself must qualify as a real estate activity plus you need a log that shows you have spent more hours in these activities than any other trade or business. If this is all you do, and the activities do indeed qualify and it’s more than 750 hours, you will pass this test. However, remember this is just test #1 of 3.

Test #2: You must materially participate in the activity. There are 7 ways to qualify for material participation, but if you have a member-managed LLC, you can end up with only 3 ways to qualify or even not qualifying at all. The best type of structure to have is a manager-managed LLC with you named as a manager. If you have the wrong structure or do not meet one of the hour requirements for material participation, you will flunk this test. My guess is this is what the auditor is concerned with. If he feels you have not demonstrated that you have material participation in accordance with the very clearly defined rules, then you will flunk Real Estate Professional status for this property.

Test #3: Each activity and each property must individually qualify under the material participation rules, unless you have previously made an election to aggregate the activities and properties on your tax return. This could also be the issue with your return. If you did not make the aggregation election in that year and failed to show him where you made it in a previous year, he will disallow the election.

The Real Estate Professional status has been more closely defined recently by Tax Court cases and new IRS Treasury regulations. It’s also an area that the IRS is targeting.

Please check out the Real Estate Professional Update webinar at http://www.RealEstateLoopholes.com.

If you’ve got a question, here’s how you can get it answered: http://www.ustaxaid.com/got-a-tax-question/

(Originally broadcast May 4, 2013)