It's Never Too Early to Plan,
But Sometimes It Is Too Late
Tax and Financial News
It's Never Too Early to Plan,
But Sometimes It Is Too Late
This month we are going to talk about cash. No, we're not going to tell you how to make cash. You've probably already found a way to get your hands on some of the green stuff, and, besides, in Secret Service circles, the act of making cash falls under the heading of "criminal enterprise, a.k.a counterfeiting." Given the fact that you are reading this article, it might also be logical to assume you're trying to hang on to what you have before trying to earn a little more cash.
Okay, enough humor, let's get serious. This month seems to be a good time to remind you that the time has come for you to take a good, hard look at the rest of 2005. You've made it through the first half of the year and even the first month of the second half of 2005, but how have things worked out? Is your actual income meeting your expectations? How well did you budget your expenses? Have you been hit with any surprises? How does the rest of the year look as far as income is concerned? Unless someone else is paying your bills, it's a good bet that you, your spouse or both of you are the only people who can answer these questions.
Assuming your plans have gone awry somewhere, what can you possibly do to get back on track? Do you even want to get back on track? Perhaps you're earning far more this year than you expected or expenses affecting taxable income are less. Do you really want to see this trend continue? Since you know the next sentence will say something like, "There could be a number of reasons that you don't want the trend to continue," we won't say it. Let's take a look at a few situations where you may want to alter your course a bit in the next five months.
The "I'm Making a Fortune this Year" Syndrome
Have you ever gotten a big bonus? If you have, the feeling is terrific. One day, you're living from paycheck to paycheck; the next day you get this huge bonus and...and...well...you're still living from paycheck to paycheck, but at least the credit cards are paid. Regardless of what you do with a bonus check, assuming it exceeds your expectations, you feel like you've been validated.
You feel great, that is, until you see the guy from English 101 who never made it past the first semester in college and he tells you about his great invention and how much he's making in royalties from the manufacturer. He goes on to tell you about his mansion, the yachts on each coast, his classic car collection and about a million other things; it's all you can do to keep from strangling the guy. He finally finishes, you walk away, and when he's out of earshot, you start muttering something like, "It's a sin that guy's doing so well and I'm killing myself just to make ends meet." Does this situation sound at all familiar? Perhaps you are the guy who didn't make it past English 101 and you're making a fortune. No? Well, let's put you in that situation. You are hereby promoted to billionaire status (for a little while) and you have a problem. You are making so much money that the taxes are going to kill you this year. How's that for a turn around in your fortunes? Now before you start patting yourself on the back, there's one little twist...your profits are paper profits and you won't see any cash until long after the taxes are due.
This may seem incredible, but it does happen. One of the more common places we see this happen is when someone sells a business and has to recapture a lot of depreciation. Normally, gains from such sales track the cash, but any recapture income has to be recognized when received. Promoters of oil & gas wells can get caught in a situation where the costs to put the deal together have to be capitalized and written off over a long period, but the income earned on the sale of the properties in the deal has to be recognized immediately.
Is there really anything you can do in circumstances like these? There may be a few possibilities. The first is simple - ask the bank for a loan. You might even ask the IRS for an installment payment agreement. Between the two, go for the loan. Interest and penalty continue to accrue on any unpaid tax. Better yet, take a look at your other assets. Perhaps, you have some losers that will remain losers. Can you sell them, take a loss and raise the cash? Maybe you don't have enough in capital gains to offset the losses, but if the numbers are big enough, the pain of carrying over the loss to another year could be worth it. After all, you may only have to carry the loss over for one year.
Let's go back to the loan idea for a moment. Do you have any equity in your home or a second home? Remember, if you borrow money to pay your personal taxes, the interest is non-deductible. If you have equity in your home, you could borrow against it, in which case the interest would be deductible.
There is a better way than all of the preceding ideas - structure your cash payments in any deal to at least pay the tax bill. Decide what you want to do, then allow all of your advisors, including tax advisors, the opportunity to review the documents before committing yourself.
Today's loss is tomorrow's tax deduction
Have you ever received a "dear reader" letter? If not, here's your first such letter:
Is it really true that a loss today saves you money on your tax return this year?
Please answer this question with a firm, unequivocal "maybe." Without knowing the nature of the loss, you can't really say whether you can deduct the loss. A loss on the sale of your home translates to zero tax savings, while a loss on the sale of an asset used in your business should save you a few bucks.
Let's say you sell some real loser stocks and have a capital loss of $10,000. That would be a pretty nice deduction, wouldn't it? The only problem is you have a $15,000 loss carryover from last year and no current capital gains. There goes your $10,000 deduction for this year. Would you like to carry your now $25,000 net loss forward, or do you have some capital assets that you have wanted to sell, but hated paying the taxes? Selling the gain property and paying no tax just got to be pretty attractive don't you think?
Of course, you have to think about the nature of your gains and losses to make sure you don't blow it. Say the loss came from disposing of the dump truck you used for your business. That's nothing more than an "ordinary" gain and it is not limited to $3,000 annually. Well, what do you know, you didn't have to sell that gain property after all.
Brevity can be beautiful
This may not be the shortest article you will read today, but hopefully, it hasn't bored you to tears. Even more important is that this article lights a fire under you if you have any similar situations or if there are other circumstances where the planning you did at the beginning of the year may not serve you well in the current circumstances. Don't complicate your life. If you are in the process of selling your business, cashing in on an investment or find yourself in any uncharted financial or tax territory, give us a call. This firm exists for one reason - you. Around here, the client is always first. Give us a chance to prove it.
Have a great August!
These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.