July 2010 Archives

July 26, 2010

Should You Lease or Buy Your Car?

When you lease a car, you are paying rent for it--a set fee each month for the use of the car. At the end of the lease term, you give the car back to the leasing company and own nothing. As a general rule, leasing a car instead of buying it makes economic sense only if you absolutely must have a new car every two or three years and drive no more than 12,000 to 15,000 miles per year. If you drive more than 15,000 miles a year, leasing becomes an economic disaster because it penalizes you for higher mileage.

There are numerous financial calculators available on the Internet that can help you determine how much it will cost to lease a car compared to buying one. Be careful when you use these calculators--they are designed based on certain assumptions, and different calculators can give different answers. For a detailed consumer guide to auto leasing created by the Federal ­Reserve Board, go to the Board's website at www.federalreserve.gov/pubs/leasing.

For more information on deducting car and local travel expenses, see Deduct It! Lower Your Small Business Taxes, by Stephen Fishman (Nolo).


July 19, 2010

Hobby Versus Business--A Significant Tax Difference

One of the most powerful weapons in the IRS arsenal is the hobby loss rule. Under this rule, only taxpayers engaged in a bona fide business--as opposed to a hobby--can take business deductions. This means you need to be regularly engaged in an activity and your primary purpose must be to earn a profit. You don't have to show you earn a profit every year. But making a profit must be your primary purpose. Your business can be full time or part time, as long as you work at it regularly and continuously. In contrast, if the IRS decides that you are indulging a hobby rather than operating a business, you will face some potentially disastrous tax consequences. You may still be able to deduct some of your hobby-related expenses but there are serious restrictions and limitations on these deductions.

The IRS has established two tests to determine whether someone is in business. One is a simple mechanical test that looks at whether you have earned a profit in three of the last five years. The other is a more complex test designed to determine whether you act like a business. Under this test, the IRS looks at certain objective factors to determine whether you are behaving like a person who wants to earn a profit. The most important of these are that you act like you're running a business, you have a certain amount of expertise in the area, and you spend sufficient time and effort on the activity.

For more information, see Home Business Tax Deductions; Keep What You Earn, by Stephen Fishman (Nolo).

July 11, 2010

IRS Tips for Students With Summer Jobs

Summer is here and many small businesses are hiring students for full or part time work. For some of these newly-employed, it may be their first time earning money and their first introduction to tax obligations and the IRS. Here is a list of what the IRS wants income-earning students to know about their tax obligations.

o All employees fill out a W-4, Employee's Withholding Allowance Certificate, when starting a new job. This form is used by employers to determine the amount of tax that will be withheld from your paycheck. If you have multiple summer jobs you will want to make sure all your employers are withholding an adequate amount of taxes to cover your total income tax liability. To make sure your withholding is correct, use the Withholding Calculator on www.irs.gov
o Whether you are working as a waiter or a camp counselor, you may receive tips as part of your summer income. All tip income you receive is taxable income and is therefore subject to federal income tax. 
o Many students do odd jobs over the summer to make extra cash. Earnings you received from self-employment are subject to income tax. These earnings include income from odd jobs like baby-sitting and lawn mowing. 
o If you have net earnings of $400 or more from self-employment, you will also have to pay self-employment tax. This tax pays for your benefits under the Social Security system. Social Security and Medicare benefits are available to individuals who are self-employed the same as they are to wage earners who have Social Security tax and Medicare tax withheld from their wages. The self-employment tax is figured on Form 1040, Schedule SE. 
o Food and lodging allowances paid to ROTC students participating in advanced training are not taxable. However, active duty pay - such as pay received during summer advanced camp - is taxable. 
o Special rules apply to services you perform as a newspaper carrier or distributor. You are a direct seller and treated as self-employed for federal tax purposes if you meet the following conditions:  You are in the business of delivering newspapers. All your pay for these services directly relates to sales rather than to the number of hours worked.  You perform the delivery services under a written contract which states that you will not be treated as an employee for federal tax purposes.  Generally, newspaper carriers or distributors under age 18 are not subject to self-employment tax.