Are you a Material Girl/Guy?

I'm never sure when I listen to Madonna sing "Material Girl" if she thinks that being a material girl is a good thing or a bad one. But being a material girl/guy in relation to your business is definitely a good thing when you are dealing with IRS matters.
If you own a business and that business incurs a loss, the amount of the loss that is deductible for tax purposes may be limited by several factors. One factor is whether you materially participate in the business. Material participation only becomes an issue if your business is organized as a pass-through type entity (sole proprietorship, partnership, S Corporation or LLC for tax purposes treated as a sole proprietorship or partnership).

Before I discuss what factors the IRS uses to determine material participation, a little necessary background info. about pass-through entities. In pass-through entities, the profit or loss is calculated for the business as an entity and the information is submitted to the IRS but no tax is due at the entity level. The profit or loss is "passed through" to the owner(s) and included on their personal return. If a loss is passed through, it can generally be applied against other types of income such as wages, interest and dividends. That makes a loss valuable to the taxpayer because it can decrease the total amount of tax due on the return. However, if an individual does not materially participate in her business, losses are treated as "passive" losses, which mean they generally are only deductible against passive income such as rent, royalties or other businesses with passive income. Not so useful now, right?

What factors does the IRS use to determine material participation? Generally, for an individual to be considered to materially participate in a business, she must be involved in its operation on a "regular, continuous and substantial basis". More specifically, there are seven tests that the IRS uses to determine material participation and a business owner must satisfy at least ONE of the tests:


* 500 Hours: individual participates in the business for more than 500 hours during the tax year.
* Substantially All of the Work: the individual's participation constitutes substantially all of the participation in the business compared to all individuals involved in the business.
* More than Anyone Else: the individual participates in the business for more than 100 hours during the tax year and that time is not less than any other individuals involved in the business.
* Significant Participation Activity: The activity is a "significant participation activity" (SPA) and the sum of SPAs in which the individual works 100-500 hours per year exceeds 500 hours for the year.
* 5 Out of 10 Years: The individual materially participated in the activity for any five tax years during the prior ten tax years.
* Personal Service Business: If the individual materially participated in the activity for any three tax years preceding the current tax year and the activity is a personal service activity, the loss will be treated as non-passive. A personal service business is one in which capital is not a material income-producing factor. Examples of PSBs are accountants, lawyers and doctors and in the equine world, free-lance instructors and equine chiropractors.
* Facts and Circumstances: The facts and circumstances test may apply if none of the other tests are met. This test does not apply unless the individual worked more than 100 hours a year. Also, the taxpayer's time spent managing will not count if:o A paid manager participates in the business, ando Any person spent more hours than the taxpayer managing the activity.


Material participation is determined on an annual basis so you may be considered to materially participate in your business one year and not another.


Material participation is only one factor that can limit the amount of loss available to the business owner. Other factors include limitations due to basis, amounts at risk and hobby loss rules. So be sure to consult with a qualified tax advisor to understand all of the factors affecting your situation.

The first year that I prepare a tax return for a client, it isn't unusual for me to get a lot of receipts for deductions for clothing related to their job or business. Many times, I have to be the bearer of the bad news that the cost of most of the clothing is not tax deductible. The types of clothing that are tax deductible are very limited and I use what I call the "Department Store Rules" as general guidelines to determine what is and is not deductible. My "Department Store Rules" are 1.) Can you buy something similar to your potentially deductible clothing item in a department store? 2.) Would most people feel comfortable wearing this item of clothing into a department store? If the answer to either question is "Yes", chances are that the cost of the clothing is NOT deductible. So on the "NOT deductible list would be items such as:

Sports bras
Muck boots
Favorite polar fleece jacket even if that jacket is manufactured only by an equestrian clothier
Extra warm coat you wear when you are giving lessons, teaching a clinic, judging, etc.



You get the idea.



So what is deductible?



Protective/Safety Clothing: hard hats, riding boots, chaps, riding gloves, protective vests and any other type of protective clothing not suitable for everyday wear.








Show Clothing: breeches, top hat, hunt jacket, etc IF the showing is a business expense (e.g. you are showing your clients' horses, sale horses, etc) AND the item of clothing is not suitable for everyday wear (e.g. your lucky show socks, the T shirt you wear under your show coat ...).



Something you can do to expand this rather narrow window of what is deductible very slightly is to have some of your regular business-use clothes embroidered with your logo or otherwise use them as a marketing device. For a trainer who frequently coaches at horse shows, you could have your baseball cap and jacket embroidered with your business logo and the cost of the clothing and the embroidery would normally be deductible. Don't go over the top on this idea and have everything in your closet embroidered or the IRS could disallow all of the deductions. Weigh the cost of the tax savings you gain by getting the deduction and the possible marketing benefits against the cost of the embroidering to see if the idea works for you.





Remember that for any expense to be deductible it must be a business-related expense, ordinary (common and accepted in your type of business), necessary (helpful and appropriate to your business) and you must have documentation (receipts) that you actually incurred the expense.








So on your next trip to the tack shop, remember my "Department Store" Rules and you'll know how much of your purchase should be tax deductible.

It's all about you!

You can have the best employees in the world but the reason most clients will start to do business and stay with your business is because of you. This business was your brainchild, is your heart and soul, you who makes or loses money...no one should be more invested in your business than you. But sometimes, it's not just working hard. It's working smart.



For example, you could try to save your business some extra dollars by doing all of the office work yourself. But if you are out in the barn, instead of in the office, you can connect with clients and employees. Checking in with clients may result in additional lessons, training or showing and can certainly result in more revenue for your business than whatever you'll save working in the office. You don't have to hold big parties or give great Christmas gifts. It can be as easy as taking a couple of photos of great moments in a lesson and e-mailing them to the student (or student's parents) later on.



Clients want to be treated "professionally". By dressing appropriately and focusing on your clients' needs, you show that you value the time and money that they are spending on your business.



You can also create goodwill by being approachable when you are away from home. Potential clients frequent the rail to watch how you interact with your students and horses in training. But be sure that potential clients can identify who you are by jackets, saddle pads, etc with logos that are easily readable from a distance. Check with your showing association to see what is allowed.



Try to find high exposure opportunities to which you can donate your time - clinics to benefit a cause, speaking at your breed or show association, etc. The return on your time will be rewarding to your business in terms of good PR and eventually, in dollars of revenue as well.



In the end, EVERY business decision you make (and remember, not making a decision is really making a decision not to act) effects the bottom line of your business. Represent your business well and work smart and you'll get monetary as well as personal satisfaction from your career.

Even the most diligent employees won't watch over your money as carefully as you do. So if you aren't responsible for all of the purchasing decisions at your farm, you need to create incentives for employees to make cost-conscious purchases. The easiest way to do this is to set an annual budget for each type of recurring purchase - feed and grain, supplies, maintenance, etc. The budget should be attainable and realistic and there should be some reward to the person responsible for purchases (e.g. barn manager) for coming in at or under budget. Suggest possible strategies for reaching the budget goals - purchasing in bulk, buying generic rather than name brands, etc. Require that any major changes be subject to your review before making the change. You want to save money but you don't want to replace a satisfactory product with an inferior one.

Another way employees can help save you money is by following established safety procedures. Accidents or injuries due to an employee neglecting to follow established safety rules will be reflected in increased rates for your workers compensation and general liability insurance. If your worker is injured, it will cost you money in the form of additional labor costs, possible reimbursement of medical costs and even potential lawsuits.

Is it possible to utilize your workers to do some of non-income producing work that you currently do? If you could be producing income but are instead stuck behind a desk, that's a lost opportunity cost. For example, if you can find a suitable substitute, you can hand over responsibility for monthly invoicing of clients and start teaching more lessons yourself. Finding a suitable substitute may mean hiring a part-time bookkeeper at an hourly rate less than what you'll be making teaching lessons. You'll be making more than you are spending for the bookkeeper and you'll be interacting with clients, where you belong.

Ask your employees for suggestions for cost-saving measures. They may notice poor quality or waste that is costing you money. They see a side to your business that you may not and can be a great source for ideas. Also, including your workers in the decision-making process is great for team-building and instilling a greater sense of responsibility.

Your employees can be a drain on your business or a resource for your business. It's up to you to create a work environment to benefit you both.

Equine Accounting: Looking for "People People"

When you look for an employee for your horse operation, you want someone who is good with horses, someone who can paste worm the most difficult horse in the barn with one hand tied behind their back, clean five stalls in less than five minutes and other equally impossible tasks. A big part of your livelihood comes from horses so, of course you want to hire employees who are strong in those skills - "Horse People"

But horses are only half of the equation. Horses are owned by people, expenses incurred by horses (like hay, grain and shavings) are paid by people and some people can complain a lot more loudly than most horses if they aren't happy with the services provided. Yet most employers don't consider the skills that are required for good customer service when making a hiring decision - "People People" and not just "Horse People".

While it isn't likely that most of the job applicants for horse businesses have had extensive training in customer service, some may have had experiences that will serve as a good basis for developing awareness and consideration of customer needs. So don't just focus on how many barns the applicant has worked at in the past. Also ask about experiences working in retail or service industries, where customer service is key.

No matter what their experiences, you need to provide training so your employees KNOW how you want them to handle a situation. Role play scenarios and offer suggestions for responses. When a client mentions that she heard that her horse wasn't turned out today as promised, "I forgot" is not an appropriate response but "Let me find the barn manager/owner and I'm sure she can answer your question" might be one example of how you'd like your employees to address the situation.

Spend some time in your barn and listen with the ears of a customer, not the owner. You might be surprised at what you hear - a barn manager berating an employee at full volume, a barn employee explaining to a customer why she hates working there, etc.

Good "People People" employees = satisfied customers who are eager to patronize your business and put money in your pocket. So invest in your employees by providing them with the customer service skills they need to help make your business a success.

Visit my website www.blueribbonaccounting.com to learn more about equine businesses.

Equine Accounting and Taxes: And with Sales Tax, your total comes to $$$....

Before someone goes on a horse hunting trip, hopefully they check their wallet to see that they have enough money to cover the cost of the horse, the vet check, transportation costs, tack (because the new horse is always a different size that all of your current tack), etc, etc. But many potential buyers never consider that sales tax may be due on their purchase.

There have been efforts to create a uniform sales tax that would be the same for all states but for now, each state regulates the imposition of sales tax in that state. As I mentioned in a previous post, some states charge sales tax on horse boarding. But many more charge sales tax on the sale of horses. Generally, most sales of tangible personal property are taxed and horses would meet that description.

If you purchase tangible personal property in a state with no sales tax, or the sales tax percentage where you made the purchase is less than your home state, you may be liable for use tax for the “use, storage or consumption” of that property in your state.

Because each state is different, I can’t write 50 articles about sales tax on the sale of a horse. But I can tell you about a situation which is a good example of possible sales/use tax liability for someone engaged in the business of selling horses. A regularly imports horses from Europe, both as an agent for his clients and buying horses directly himself, for training and resale later. A had a working relationship with several sales barns in Europe. So for purposes of simplification, even when acting as an agent for a client, it was A’s name on the paperwork for U.S. Customs. A was recently contacted by the Department of Revenue for his state regarding use tax liability on the horses purchased in Europe and brought to his state. If his state decides to audit these transactions, they could audit multiple years and some states have no statute of limitations for the examinations of returns. With some states charging as much as 60% in penalty and interest, this could become a very expensive problem for A.

There are many possible scenarios for the sale of a horse including: resident seller to resident buyer, resident agent (who holds no title to the horse) to resident buyer, resident agent to nonresident buyer, resident seller to nonresident buyer and nonresident seller (outside United States) to resident buyer and each may involve sales/use tax liability.

In my state of Massachusetts, if a horse residing in Mass is purchased and delivered to another state, the seller should provide the buyer with a letter of delivery. If there is sales tax in the new owner’s state, the new owner is responsible for the liability. But, if the horse comes back into Mass to live within six months of purchase, the owner would be responsible for Mass sales tax if they had not paid sales tax in their state. Sound complicated? It is. Some CPA firms specialize in this area due to the complexity and variety of regulations among states.

Though sales tax audits may not sound as familiar as an audit by the IRS, they are much more common. And with the current state budget shortages, some states look to sales tax audits as a way to make up some of the difference. So it’s important to the future of your horse sales business to learn more about the sales/use tax regulations of your state. Contact your state Department of Revenue as well as your state horse council, farm bureau or other related agency for general information. If you find that you have a potential sales tax liability, contact an attorney or CPA who specializes in this area.

Equine Accounting and Taxes: Potential Sales Tax Liabilities for your Horse Business

A potential client contacted me to ask if I would be willing to prepare her sales tax return for her. I've prepared sales tax returns for over 20 years so this should be no problem. "What have kind of product have you been collecting sales tax on?" I asked.

"Horse board".

"Are you sure about this?"

She sounded pretty sure. So I decided to investigate myself.

She lives in New York State, so I contacted the New York State Department of Taxation and Finance. Yes, I was told, horse boarding in New York State is subject to sales tax. The customer service rep there referred me to their tax regulations and several tax memos and advisories. Further digging uncovered the NY State Horse Council, which has website including an index of legal issues affecting horseman, including a list of what is and is not subject to sales tax for commercial horse boarding operations.

Sales tax is regulated by individual states, or in some cases, individual counties or cities. But there are some general concepts. Generally, all tangible personal property is taxable except with exemptions. So if you are a farrier and also sell hoof supplements to your customers, in most states you would be required to collect and remit sales tax on the supplements you sell. In many states, sales tax should be collected and remitted for sales of horses - a subject to be discussed in a future newsletter.

The difficulty sometimes becomes defining what tangible personal property is. In NY State, horse boarding is compared to leasing storage space. It's the stall itself that is considered to be the primary item in a boarding transaction, so sales tax is assessed on that tangible personal property. If in a sales tax audit, you feel that sales tax should not be assessed on a certain type of personal tangible property, the burden of proof is on you -the taxpayer- to prove this is the case. Conversely, generally only certain services are taxable. In a sales tax audit, the burden of proof is on the auditor to make the case that the services at issue are subject to sales tax.

Sales tax audits are much more common than IRS audits of income tax returns. Some states have no statute of limitations for examination of prior years' sales tax returns and penalty and interest can amount to up to 60% of the tax.

What can you do to find out more about the possibility of sales tax liability for your horse business?

1. Contact your state Department of Revenue. Ask for information regarding what goods and services are taxable in your state.

2. Contact your state Farm Bureau, Horse Council, etc. for more information. If you feel that you may have potential sales tax liability, ask them to recommend an attorney with expertise in this area.

3. Contact a CPA firm or attorney that deals only with matters of sales tax. Sometimes, this is less expensive than people fear and gets them a definitive and relatively quick answer. If you do need to collect sales tax, you will need to register with your state but speak with the attorney or CPA first. There could be serious tax consequences if you register and owe back taxes. Your attorney may be able to negotiate a settlement before you register. If you register first, the chances of negotiating a settlement is very small.

4. If you don't use one already, consider putting your financial data into an accounting software program like QuickBooks. You can create invoices with sales tax included and track and remit sales tax liabilities relatively easily using QuickBooks.

Remember that each state is different. Find someone that is familiar with the sales tax regulations that affect you. A little attention now may save you time and money in the future.

Famous Last Words... My tax situation is pretty simple

Several years ago, I met a woman who was involved in carriage driving. I remarked on how well behaved her horse was and asked who trained her. The woman said that she got the horse from a family who bought the filly as a yearling and trained her themselves. They had never owned a horse before and decided that as a family project, they would buy a horse and train it to drive. Their only resource for how to train the filly was a book that they bought on raising and training horses.
A lot of you who are reading this are probably cringing, thinking of all the ways this experience could have gone terribly wrong. 99% of the time, it wouldn't have a happy ending. Horses are complicated and some of the time most of us need assistance from professionals who know how to do the job right.
Most of us wouldn't try to do electrical wiring or writing our own legal contracts. So why do so many people do their own tax returns?



It isn't uncommon when I first meet a prospective client or speak with an attendee at a seminar that they tell me that their tax situation is pretty uncomplicated. But when we go on to discuss the situation further, it can prove to be anything but straightforward. As I start to explain the intricacies of some of their tax issues, I hear "How am I supposed to know that?" or "This is more complicated than I thought".

Quoting U.S. Representative Spencer Bachus from AL:

"With its 6,000 pages and 500 million words, the complexity of our tax code is the prime source of frustration and anger felt by millions of Americans toward their government."




CPAs and Enrolled Agents spend a significant portion of time staying informed about current tax law. How can someone who only prepares one tax return once a year be aware of all of the issues that can affect their tax situation?



Here is a sample of questions that I've heard recently:



Personal:

1. Is the scholarship I received taxable?

2. How much of my Social Security benefits are taxable?

3. I surrendered my life insurance policy for cash. Does that affect my taxes?



Business:

1. If I give my employees gifts for Christmas, is the cost deductible?

2. If I am a one person S Corporation, can I set up a health insurance plan for myself that is non-taxable to me and deductible for the corporation?

3. What is a Section 179 deduction?



If something is wrong on your tax return, it may be a red flag to the IRS which can trigger an audit or it may increase the amount of taxes you pay or decrease the amount of your refund. But it's not something you realize at the time. It can take years to discover the problem which could translate into amending the tax returns for all the years involved.



There are certainly people other than CPAs and Enrolled Agents who can correctly prepare a return. And there are tax returns that are fairly simple and straightforward for the average taxpayer to prepare. How do you know if that's your situation?



1. You can hire a tax preparer to review your prior year return to see if you have any potential problems.

2. You can hire a tax preparer to prepare your return this year. Compare it to what you did last year (assuming your situation has not changed significantly) and see what the differences are.

3. Schedule a consultation with a tax preparer and explain your business or personal situation. They may be willing to point you toward tax issues specific to your situation.



Tax returns done wrong can be a costly problem to remedy. Get expert advice and then decide whether preparing your tax return yourself is the best alternative for you.

Equine Accounting: Qualified Joint Venture for Husband and Wife Operations

At many horse farms, the revenue from the farm represents the primary source of income for both the husband and the wife. In order to receive credit for their income for purposes of calculating future Social Security benefits, many couples have resorted to changing their form of taxable entity from sole proprietorship to a partnership or S corporation. This results in an initial expense for legal costs as well as additional fees for preparation of more complication partnership or S corporation returns each year. However, there is another less expensive and less complicated option: the qualified joint venture.

Beginning in 2007, an unincorporated business that is jointly owned by a married couple may elect to be treated as a qualified joint venture. The couple must file a joint tax return. Each spouse must "materially" participate in the business and the business may not be owned in the name of a "state law entity" - an LLC or LLP.

Each spouse must report their share of the all of the business income and deductions and each will receive credit for purposes of Social Security benefits calculation. The division of income and deductions between the couple should be based on each spouse's interest in the business. Generally, this can be calculated based on time and/or funds invested in the business. So each spouse would include in their jointly filed Form 1040 a separate Schedule C or Schedule F, with their share of income and expense as well as a separate Schedule SE to report self-employment tax. In most cases, this division of income does not increase the amount of tax due.

If, however; Spouse 1 substantially controls the management of the business and Spouse 2 is under the "direction and control" of Spouse 1, an employment type of relationship exists and would not meet the criteria of a qualified joint venture. Spouse 2 should be considered an employee and is subject to income tax and FICA (Social Security and Medicare) withholding. As the employer, Spouse 1 is responsible for FICA taxes but not Federal Unemployment Tax.

Why is this important to know? If you and your spouse are planning to spend a considerable percentage of your working life on the farm, you need to be sure that each spouse is accumulating wages that are included in calculating future Social Security benefits. We don't like to think about the possibility of losing our spouse but especially in the case of a family with children, it's important to plan in advance to minimize the economic impact of the death of a spouse.