Thursday, October 2, 2014

Financial Power and the Importance of Reserves to You



There are two reasons that make financial reserves important to you. One reason is defensive the other is empowering.
Defense for an Emergency
When traveling through remote areas you probably like to keep plenty of gas in your tank as the next gas station might be many miles away. It works the same way with money. We never know when we could suddenly lose an important source of revenue like your job or an important piece of business. So it is the course of wisdom to save up money, a reserve, just in case you need it when the unexpected happens.
The standard recommendation use to be to have at least two months of reserves in the bank. But the world has changed and you may need to have more than two months. Consider your situation and have a plan in place for what you will do if your cash flow dries up. How much would you need until you can land another job or get enough additional business to replace the cash flow? These questions should give you an idea about how much you need.
Power to avoid an Emergency
There is a much more powerful reason to have a reserve also. Consider, you can put your reserves to work for you by investing them. You might even want to get enough in liquid and semi-liquid investments that you could live off the income they produce if you need to. Think of the power you will get from your investments and they will provide for you. If you have reserves working for and you lose your job or some business then the loss need not be a disaster for you.
When we think in terms of gaining power we have a much stronger motivation to work a plan to reach our goals. While it is important to have reserves in the case of an unexpected change it is much more powerful to have reserves to keep the unexpected from becoming a disaster. It feels much better to rely on your own investments than the fortunes of a company you work for.
Financial Plan
Typically the financial plan will first include establishing a reserve, for an emergency, that you will want to have in a very liquid account. Then beyond that your investments can be in less liquid accounts which will typically give you the opportunity to generate higher returns on your money. Just think about having money in investments that you can fairly easily liquidate to cover necessary expenses or even better to take advantage of better investment opportunities.
Executing the plan involves doing without some things now so you can add financial power to your life. It is worth giving up some things now to get power over your finances and life.
The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Tuesday, September 2, 2014

What Will Your Taxes Be On The Sale Of Your Rental Properties?



The idea for many with rental properties is to have a stream of income now and assets to sell when you retire. Very seldom do I hear people with rental properties talk about how much of a tax burden they will have when they sell the properties and this concerns me because they may be in for a big surprise.

Capital Gains

There are a couple of components of income taxes when you sell a rental property. Assuming you cannot exclude the gain (have not owned and lived in the property sold as your main home for at least 2 of the last 5 years), then you will be looking at Capital Gains Tax on the gain on the sale of the property. The gain generally is what you sell the property for less the cost of the sale and less your adjusted basis in the property.

Generally your basis is your cost of acquiring or building the home that you have not deducted previously on your tax returns. You may have additions or reductions of basis for various things which are detailed in IRS publication 523 Selling Your Home.

Hopefully your property will have appreciated in value and you will have to pay the Capital Gains Tax. While no one likes to pay taxes, in this case it is better than not paying the tax because generally that would mean your property decreased in value. The good thing about Capital Gains is the rates are currently favorable to ordinary income tax rates. For example if your ordinary income tax rate in the year of the sale is 0 to 15% then your Capital Gains rate would be 0. Up to the 33% income tax bracket your Capital Gains rate would be just 15%. So you can be happy that you aren't paying higher rates on your gains.

Depreciation Recapture

While most have an expectation for the Capital Gains Tax when they sell their rental property most are not aware of this second component of taxes when you sell your rental properties. When you sell a property that was a rental property you will generally have the recapture of depreciation previous taken or allowed even if you did not take it as a deduction. This means that the depreciation deduction you get to benefit from every year is taken back when you sell the property and you pay the higher ordinary income taxes on the depreciation recaptured. So with the depreciation it is really like you get to differ income equal to the depreciation until you sell the property. That is good news for you now on your tax returns but you have "pay the piper" that is the IRS later when you sell the property.

The depreciation recapture can be a large tax "hit" for you.  For example if you have or were allowed to fully depreciate a $200,000 home (excluding what you paid for the land) over the time you owned the property you will be looking at paying ordinary income taxes on the $200,000 depreciation recapture and if you are in the 33% tax bracket, for example, your tax on the recapture could be $66,000 ($200,000 X 33%).  Ouch.  And a double ouch if you are not expecting it...an unexpected $66,000 tax "hit" in retirement can really "throw your plans for a loop."

It is much better to be aware of these tax implications before you sell the property. It is actually best to know about these tax considerations before you invest in the property to begin with so you will know what to expect when you sell the property in retirement.

There are many more circumstances that can affect your tax situation when you sell a rental property, such as if you both owned and lived in the property as your main home for at least two of the last five years. Or if you used the property for business purposes. Your basis is different if you inherit the property, and there are ways to defer the gain on the sale of a rental property but not the depreciation recapture. Again, you can see  IRS publication 523 Selling Your Home for more information about your taxes when you sell your home. Also, you can feel free to contact me to go over the projected tax situation before you sell your home or ideally before you invest in properties. I would be happy to help you understand and prepare for tax considerations and include them in your plans.

Plan to Leave to Your Heirs - Tax Advantage

Most educated investors with rental homes and commercial real estate plan not to sell the property themselves but to leave it to their heirs.  When a property passes at the death of the owner the heirs who inherit the property get a bump up in basis to the Fair Market Value at the time of death.  Technically then the heirs could sell the property at the time of death with no tax consequences in many cases.  You if own investment real estate you may consider holding on to it until death and find other ways to get cash out of it if you need it.

1031 Exchange

The other option is a 1031 exchange for similar property.  This typically won't give you cash but it may enable you to switch properties without the tax consequences of a sale.

Both the 1031 exchange and the tax treatment of real estate upon death will be subjects of coming posts.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Friday, August 22, 2014

When and How to Use Retirement Accounts



Really successful people do things that others do not do.  One of those things is use of retirement accounts in a powerful and purposeful way.  When and how should you use retirement accounts?

Retirement accounts are useful for two things.  One is to defer taxes and the other is to force you to keep that money set aside for retirement or pay a penalty.  All retirement accounts but ROTH IRAs can grow tax free until you take the money out at which time the entire amount you withdrawal is taxable income to you.  During the year you turn 70.5 years old you are required to take what are called Required Minimum Distributions.  So while you don't pay taxes on that income now the intent is for it to become taxable income to you at some time in the future.

When Should You Use Retirement Accounts

So contributions to your retirement account(s) are deductions for you on your tax return in the year the contribution is made (possibly until you file your tax return).  Reducing your taxable income this year is good right?  In a way, yes, because you reduced the amount you owe in taxes this year but you also just lost control of that money until you turn 59.5 years of age unless you pay a penalty (and yes there are some exceptions).

What is the big deal about not being able to access that money for a long time?  You need to realize that your money in retirement accounts is not really available to you in case of an unexpected emergency like a lost job.  Also, for the most part you cannot get at that money to fund your start-up business or other business investment opportunities.   The suggestion is that you have at least three if not six months of reserves on hand to cover your cost of living in the event of the unexpected.  In addition, really successful people keep a healthy amount of liquid funds that they can use to finance other investment opportunities.  So really you want to both contribute to your retirement account annually but also set money aside as reserves for a rainy and grow an investment account.  Most people focus only on contributing to the retirement account and not the other savings which in a way are more important.

One great reason for contributing to your retirement account is when you employer matches your contributions.  Then you should maximize your contributions if you can also put money into savings for your reserves and add to your investment account.

One of the biggest hindrances to saving and building up reserves and an investment account is your lifestyle.  It seems people value buying things and don't really understand the opportunity value of putting their money to work for them.  You see you should have money making you more money in addition to your own labor making money for you.  As I brought out in my previous post, that really successful people build an investment account to have money working for them and they are very aware of opportunities as a result of having that money available to invest.  It is a mindset that really successful people have.

So to answer the question of when to use retirement accounts, it should be after you already have three to six months of cost of living reserves in the bank and you should have a balance between your contributions to your retirement accounts and your investment accounts.  When your employer matches your retirement contributions you may want to have more proportionally set aside for this purpose but you still want to build up reserves and investments.  It is a little different when you can take advantage of the matching provision.

How Should You Use Retirement Accounts

You should use retirement accounts to defer taxes and build up money that you can use in retirement but will be subject to tax when you take it out.  Then in retirement you will want to use these funds from your retirement account until you reach the sum of your deductions and exemptions on your tax return because after that you will be paying taxes on that money.  At that point you can take your already taxed money out of your investment accounts if needed to live off of.  The only tax you will pay on that money is on the as yet untaxed gains.  If these gains are capital gains they may not even be subject to tax.  Currently (2014) dividends and capital gains are untaxed to you until your taxable income exceeds $36,900 for a single person and $73,800 for a married couple filing jointly.  So under the current law it would be very helpful for you to be able to pull from both retirement and investment accounts when you retire.  For more on taxes on gains and dividends from investment accounts see my previous post by clicking here.

ROTH IRAs can grow tax free and are typically tax free when you withdrawal money from them after you turn 59.5 years of age and they will be the subject of other upcoming posts.

As you can see this is a somewhat complicated area and it would help to consult with both a CPA and a financial adviser.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Wednesday, August 20, 2014

Things That Will Make You Money - Number 16 - Save Money



Really successful people do things that other people will not do.  One very important thing they do is save money. I was shocked to learn from a Business Week post that:
Just 45 percent of upper-middle-class households (income from $75,000 to $99,999) saved anything in 2012, according to the Fed study. That means the other 55 percent didn’t save for a house, retirement, or education. About 16 percent spent more than they earned and went further into debt.  
The Fed study is called "Supplemental Appendix to the Report on the Economic Well-Being of U.S. Households in 2013."

So we learn form this, even the majority of the upper-middle-class do not save money. Guess what really successful people do and why? That's right they save money or put money aside but how and why?

Powerful Reasons for Saving

Yes really successful people save money but not just to save. They have powerful reasons for saving. Savings do two things for you. One is it gives you money for a rainy day when you income drops or stops for a time. The second it is you the ability to take advantage of opportunities that present themselves.  Yes, it "takes money to make money."  It is true and so to make money you need to save money to have it available for investment/business opportunities.

The really successful people have money that they can invest in business opportunities. Why not you? Why can't you be a successful person who decides where to invest their hard earned money. Yes, you too can create this opportunity for yourself by saving money. And not just saving money but saving money in a vehicle that allows you to easily and quickly access it.

After Tax Investment Accounts

One problem that most people have is they commit too much money to retirement accounts from which they cannot or have difficulty taking money out to invest in a business opportunity.  Now there are ways to use a retirement account for investments but not easily or quickly. By saving money in an investment account, already taxed, you can have quick access to funds to invest or live off of while you start a new business. In a retirement account it is not really possible to use the money to carry you over while you start a business.

Really successful people have after tax money working for them and have some on hand when opportunities present themselves. And what happens as a result? Opportunities come to them and are recognized by them. When a person has no savings they are not even looking for and hence not even seeing investment/business opportunities. But when you have saved money you are looking for things to do with it. You see saving causes you to see things differently and be open to opportunities to put your money to work for you.

If you are already positioned with savings and our looking at business opportunities take a look at my post on things to consider about business opportunities:
10 Things to Consider Before Purchasing a Business

Reserves - Prepared for the Unexpected 

Notice too this point brought out in the Business Week article:

The report highlights the consequences of these hand-to-mouth habits: Only half of these households had enough savings to finance three months of living expenses if they lost their job or couldn’t work. A $400 emergency would force about 20 percent of them into months of debt.
Really successful people are always prepared for the unexpected either good or bad. You should have access to reserves in case something happens to your source of income.  In addition a small emergency should never put you into crisis mode. 

Take charge

Take charge of your financial life.  Start saving today. Make changes in your spending habits today so that you will be in a more powerful position tomorrow. You may need to look at what you spend money on and what you own that you don't need. To succeed you will need to make choices between immediate and long-term gratification. Don't sacrifice your opportunity to develop a powerful financial position for short-term and temporary gratification.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
217-923-8007
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Monday, August 18, 2014

Things That Will Make You Money - Number 15 - Commitment



Really successful people do things that other people will not do.  You may recall this wise exchange in the movie the Karate Kid:

Either you karate do "yes" or karate do "no." You karate do "guess so,"
[squish]
just like grape. Understand?

Most people are motivated just by a chance to make some money but they do not really think things through and get a realistic expectation or are really committed to their business.  If it makes money great otherwise they give up quickly. Believe me, other people can tell when someone is really committed to a business or what they are trying to sell.  Once someone perceives you are not really committed to what you are doing it will be next to impossible to convince them to do business with you now or in the future as your opportunities "get squished just like a grape."

Really successful people commit to a business only when they are "all in" and it shows. So you have to be convinced this is "what you are going to do." Notice the difference between "what you want to do" or "you are going to try to do" and "what you are going to do."  The difference is commitment.  The commitment takes place in your mind and in the language you use to just think about the business, "going" versus "want" and "try".  Really successful people think differently and use language that is powerful and purposeful, and they are "all in".

In another post I wrote about taking action even if everything is not perfectly ready.  It that case you still need to be committed and prepared. You take action although it is not perfect and then you develop and perfect as you go. It works because although it is not perfect to begin with you are still committed.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Thursday, August 14, 2014

Things That Will Make You Money - Number 14 - Staying Power



Really successful people do things that other people will not do. Most of your competition will be gone in two years. Will you still be standing? It amazes me how many people and businesses make a lot of noise in the market and then within just a couple years  they are gone. Really successful people do not give up easily, they have staying power.

Starting a Business

When starting a business you know it will take time. Even if you are really clever you should expect it to take time to get your business to where you want it to be. Overnight success is not real and expecting it will lead to disappointment. Expect to work hard over time to develop your business. Too many start and quit before they even had a real chance at success. So have staying power by planning for it to take time to develop and grow your business. It is rare that a business even breaks even in the first few years. So be realistic and patient and give yourself a chance to succeed.
The media glorifies the rare success that appears to come about overnight. In sports for example it is rare for a program or a coach to win a championship quickly. Think of Mike Krzyzewski, who became the head coach at an established blue-chip basketball program at Duke University.  Even in an established successful environment it took him four years just to get into the NCAA tournament and eight years to reach the final four and 11 years to win an NCAA championship. Think about that, it took eleven years to reach the ultimate goal. Today many programs give up on a coach well before 11 years have past. Consider legendary NFL coaches Tom Landry and Chuck Knoll who coached for many years before they won Super Bowls. While some coaches do win quickly it comes on the backs of what others had built prior to their arrival. In these cases the foundation of these programs was built over many years.  In reality success is the result of sustained effort and progress over many years.

Staying Power

Here is the thing about staying power. People, your potential customers, are rightfully skeptical because so many do give up quickly and they want to know that you will stay around. So working at your business for years and letting people get familiar with you breeds success but again it takes time. For example, you can go to a networking meeting and there you will meet people but they have met so many people that did not have staying power.  As you would expect then, they will want to see you working your business over a good period of time in order to feel comfortable with you and believe you are determined to stay in your business.
So be one of the rare ones that stays around and succeeds. It starts with expectations. Expect it to take time to achieve success and enjoy the journey. When you finally reach your goals it will be really sweet.
Success often results from doing what others won't do and many times what you really don't want to do.  You can become more successful and have more control over and knowledge of your business,  gaining freedom from frustration, saving time and money. Please feel free to contact me using my information below to discuss how we can work together to help you with your business, income taxes and accounting.

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Tuesday, August 12, 2014

Budget for Business Owners and Workers on Commission



Making a budget is helpful especially if your income is predictable. But what about when you never know how much or when your income will come in.  That is sort of my situation and making a budget with those conditions is a real challenge and perhaps even more important to you.

Some salary and commission employees budget to live off the salary and then save and or invest the commission checks.  In this case too you can set a budget based on your salary and then make adjustments and treat yourself when the commissions come in.

But what can the straight commission people and business owners do? What you can do is the expense side. First, budget your necessary expenses like the mortgage/rent, utilities, food, transportation, etc. and leaving out optional purchases like clothes, travel, electronics, etc.  Start with money that you do have and see how long you can live off of that money.  Then as money comes in you add other non-essential expenses. As you bank money that exceeds these non-essential expenses then you can start planning what to do with it.

A good place to start with money after essential expenditures is saving and investing money. Where you put the money can be real important because the unexpected can always happen and you find yourself in need of cash.  So keep a generous amount of the money you save and invest in liquid accounts or investments. You also want to set aside money for bigger expenditures like replacing your car, getting tires, and replacing your computer that has become painfully slow.

Seven Reasons Why You Should be Investing After Tax Dollars!!!!!!!

Budgeting when your income is unpredictable is more art than science. Because your income is unpredictable you really need to keep more money set aside for the unexpected.  It is stressful but so is working the 9 - 5 in Corporate America. At least being your own boss allows you to make your own success and to be creative and have some flexibility with how you live your life. The cost is the unpredictable nature of your cash flow.  So the key is being really conservative with the money you have and the money you have not seen yet.  Then when the money comes in you can be a little freer with your money.


The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter too at:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Monday, August 11, 2014

After Tax Investments: Dividend Income > Tax Advantages



After tax investments should be a big part of your retirement plan as I previously posted.  Not only can you reduce your taxes, your after tax investments can also be accessed now without paying an early withdrawal penalty tax to the IRS. So they are a great of source of funds to pull from in the event of an unexpected emergency or investment opportunity.  But what about the tax on the profits?  That is a great question.  In fact, I received this tweet as I was writing this post:

In most cases your profits from your after-tax accounts will either be classified as dividends or capital gains. Here is how the IRS defines dividends:

Dividends are distributions of property a corporation pays you because you own stock in that corporation. 
If you read between the lines you will notice, that dividends are really your share of the profits that have already been taxed once by the IRS (technically Uncle Sam but that is splitting hairs). Distributions that are a return on your invested money are taxed as capital gains to the extent the distribution exceeds your basis.  So now that the entity is distributing already taxed profits to the shareholders these distributions are call dividends.

Ordinary or Qualified Dividends:

The dividends you receive will be classified as either "ordinary" or "qualified."  This is very important from a tax standpoint, because "ordinary" dividends are taxed as ordinary income at your ordinary income tax rate.  But "qualified" dividends that meet certain requirements can be taxed at the favorable capital gains rates.

For more information about qualified dividends see IRS publication 550.

Long Term Capital Gains Rate:
Long Term Capital Gains Tax Rates are determined by the individual's personal income tax bracket.  Below are the 2014 Long Term Capital Gains Tax Rates as they correspond to personal income tax rates.

Personal Income
Long Term
Tax BracketCapital Gains Rate
10% - 15%0%
25%-35%15%
39.6%20%
While taxes on ordinary income can range from 10% to 39.6% your capital gains rates can be much lower or even 0%.  So while your post tax investments have already been taxed, the profits on them will typically be taxed but at much lower or favorable capital gains rates.  So the taxes you pay on the profits from your investments in your after tax (investment) accounts can be taxed at much lower rates than the funds in your retirement accounts will be taxed at.

Now make sure you get this point, the tax on distributions (not just profits but all distributions) from retirement accounts are at the higher ordinary income tax rates and not the favorable capital gains rates.  So even though the profits made in your retirement accounts may be the same as capital gains they are taxed at ordinary income tax rates because you never paid tax on the money invested into the retirement account.  So of all your money taken out of retirement accounts is typically taxed at the higher ordinary income tax rates.

So once again, you can see your investment accounts (after-tax dollars) should be a powerful tool in your plan for retirement.  While your funds in retirement accounts will be taxable as ordinary income when you take them out, your post or after-tax investments have already been taxed so when you take those funds out they are technically tax-free at that point while the profit can be taxable but often at favorable capital gains rates.  So in retirement it would be nice to pull from retirement accounts up to your standard or itemized deduction and exemptions so that you do not pay tax on them. After that you can pull from post tax investments and only pay tax on the untaxed portion of the profits. In theory then you could have a tax free retirement, at least at the federal level based on today's tax laws.

For more information about retirement planning see my post: How to Avoid Income Taxes in Retirement.

In addition you can lower the overall taxes you pay over the course of your life by having funds in investment accounts and being able to pay the favorable capital gains rates on the profits instead of the higher ordinary income tax rates you will pay on retirement accounts.  It is even possible that you will pay no tax on the profits from your investment accounts if you are in the 10 to 15% tax bracket when you recognize the profits.  So while putting money in retirement accounts can reduce your taxes in the year of the contribution of those funds, the taxes are really only deferred until later when you take the money out of the account.  Additionally your money in after tax investment accounts can be accessed before you turn 59 1/2 years of age without paying the 10% early withdrawal penalty you would pay on early distributions from your retirement accounts.

So while retirement accounts have their place, their real value to you is only in deferring and not in minimizing taxes.  However, by using investment accounts you can reduce taxes and increase liquidity allowing you to "jump on" other investment opportunities when they arise.  This is a greatly misunderstood concept but with this information you are now empowered to make good decisions that will benefit you greatly now and in retirement.  I would be happy to help you take advantage of these tax planning opportunities.

With dividends too there are also many tax planning opportunities for you regarding when take money out of your personal or family C Corporation.    Since this income can be taxed to you twice you want to plan to minimize those taxes.  Up front input from an experienced CPA can help you greatly to minimize your tax burden.

For more information on dividends see IRS tax topic 404.

Finally, the IRS added the Net Investment Income Tax starting in 2013.  So you need to take this into consideration too when you are doing tax planning for your investments and retirement.  See my post on this tax by clicking here.

The CPA Superhero wants to help you to succeed in business, life, and in retirement.  While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

Follow the CPA Superhero on Twitter:


My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

Thursday, August 7, 2014

Tax Implications When You Sell a Business





What will be the tax implications when you sell a business?

Pass Through Entities:

The tax on the sale of a business will typically depend on your ownership structure and the terms of the deal.  Sole proprietors, partners, and members or shareholders of an S Corporation will be taxed according to their personal tax situation.  So a seller that has one of these structures will want to consider the overall tax consequences of the sale on their personal tax return.  The ordinary income recognized on the sale of a business can move the seller into other income tax brackets so the tax impact could be greater than just the tax on the sale, it could also increase other taxes as well.

The sellers may be taxed on the profit of the sale at ordinary income tax rates or favorable capital gains tax rates or a combination of the two depending on the types of assets sold.  So the asset allocation of the sales price is very important. From the seller's perspective it is advantageous to have as much of the sales price allocated to capital assets as possible.  The gain or loss on the sale of capital assets will typically be subject to favorable capital gains tax rates. 

Capital Assets:
Capital assets can include real property or depreciable personal property used in your trade or business and held for more than 1 year.  Capital assets do not include property held mainly for sale to customers.  Additionally, the profit from the sale of a copyright, a literary, musical, or artistic composition or similar property may be  considered ordinary income rather than capital gains.

Capital Gain or Loss:
The gain or loss on the sale of capital assets is the difference between the amount you realize from a sale or exchange of property and your adjusted basis and costs associated with the sale.  Your adjusted basis is your original cost or other basis plus certain additions (that have not been expensed and deducted already), such as the cost of capitalized improvements, and less certain deductions, such as depreciation.  Typically your cost includes amounts that were capitalized rather than expensed.

Tax Rates for Capital Gains for 2014:
The Short Term Capital Gains are taxes at the same rate as the individual's ordinary income tax rate.  For example assets held for less than one year could be subject to short term capital gains treatment. 

Long Term Capital Gains Rate:
Long Term Capital Gains Tax Rates are determined by the individuals personal income tax bracket.  Below are the 2014 Long Term Capital Gains Tax Rates as they correspond to personal income tax rates.

Personal Income
Long Term
Tax BracketCapital Gains Rate
10% - 15%0%
25%-35%15%
39.6%20%

Ordinary Income Taxes:
Some assets, such as personal property, inventory and receivables, do not qualify as capital assets and the profit on the sale of these assets and the amount allocated to a non-compete agreement are subject to ordinary income tax rates.  Taxes on ordinary income can range from 10% to 39.6%.  Then there are also additional taxes from the Alternative Minimum Tax, The Net Investment Income Tax, and the Additional Medicare Tax, and of course state and local taxes to consider.  Finally, in some cases there may be a recapture of depreciation previous taken on assets which will be taxed at ordinary income tax rates.

 C Corporations:

For businesses structured as C Corporations the tax picture is not favorable.  There are no capital gains rates for C Corporations.  The tax rate paid by C Corporations on the profit from the sale of assets is the same as their ordinary income tax rates which are as follows for 2014:

15% on first $50,000
25% on next $25,000
34% on next $25,000
39% on next $235,000
34% on excess up to $10 mil.

After the tax is paid by the C Corporation, the individual shareholders will also pay taxes on the distribution of the proceeds.  In the event the C Corporation is liquidated this return of proceeds to the shareholders would be taxed at favorable Long-Term Capital Gains Tax Rates if the shareholder owned his shares for more than a year.

Financing the sale over multiple years:
Receiving payments on the sale of assets over a period of time can have very beneficial tax implications for the seller.  The seller will usually bear the tax burden on capital assets when he receives the payments. The seller financed sale of assets are treated as  installment sales and the seller pays tax on the profit portion of the proceeds he receives in a given year.  The seller will also have taxable interest received as part of the payments.

For assets not qualifying as capital assets the seller must pay the tax on them in the year of the sale regardless of when they receive payment.


Performance based financing:


This type of earn out clause is very complicated and subject to special tax rules.  The IRS uses the term "Contingent Payment Sales" for this type of transaction.  In some situations the seller may  recognize the gain or loss currently regardless of when the payment takes place.  It can also be handled as an installment agreement recognizing the gain or income as the payments are received.  He may also be able to recognize the gain after the basis in the property sold is recovered.  The terms of the agreement can affect the profit percentage used to determine the taxable portion of the payments received in a given year.  Although this can be very complicated it can favor the seller by helping him to spread out his recognized income reported over several year.

Typically the earn outs are taxed at the same rates based on the asset allocation agreement.  In other words if the earn out payments are applied to capital assets the profit portion of the payments can be subject to favorable capital gains rates based on the asset allocation agreement.

This can also be a very powerful way to structure a deal when the two parties do not agree on the value of the business. 

Additional tips:


As you can see from this brief overview of general tax issues, there are so many variables that can affect a seller's tax situation and there are many more that were not discussed in this article.  IRS publication 544 on "Sales and Other Dispositions of Assets" contains 42 pages on this complex subject.  While this article can give a seller a general idea about the tax consequences of his sale, to understand the true tax implications of a sale there are many more factors that should be discussed with a CPA who has experience with these type of transactions. 

I used the terms "typically" and "usually" because the application of the tax law is applied based on the specific facts and circumstances of the parties involved in the transaction.  The sale of a business is such an important transaction in the seller's life and they should get help from someone experienced in negotiating such deals, good legal counsel and tax advice from an experienced CPA.  The sellers should retain an experienced CPA to do tax projections for them for the various scenarios being considered and provide suggestions to help minimize the tax consequences.   

Other Posts Related to Buying and Selling a Business:

If you are considering purchasing a business there other things you will want to consider.  For more on this subject see my post: 


If you own a business or are considering purchasing a Business you will want to have an exit strategy.  Check out my post on this subject:



I have consulted with many sellers of assets such as we have considered in this article.  If you want my assistance with the sale of your business feel free to contact me using my information below.

While my main business is preparing tax returns, I also work with clients to setup accounting systems to start, manage and develop their business(es) and develop and implement a financial plan. Contact me using my information below to schedule a free introductory consultation up to a half hour. 

Jeff Haywood, CPA

The CPA Superhero
972-439-1955
jeff.jhtaxes@gmail.com

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My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.