Basis of Assessment for Various Sources of Income

Tax Advise

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Louise is aged 50 and single. Since 1994 she has carried on a retail business as a sole trader. Her trading profits as adjusted for tax purposes and after capital allowances, for the year ended 30th April 2009 were $150,000.

The business is carried out from a number of valuable retail outlets, all of which are owned by Louise personally. These units have been acquired over a number of years since 1994 and their market values have increased considerably in recent years.

Apart from her single personal allowance tax credit, Louise is entitled to income tax relief in respect of $10,000, which she pays annually to a Revenue approved pension scheme.

Louise’s personal living expenses and other financial commitments total $50,000 per annum (including the contribution of $10,000 to the Revenue approved pension scheme referred to above).

Louise is considering transferring her business to a limited company and has asked for your advice.

REQUIREMENT:

(a) Set out the issues which Louise should consider before deciding whether to transfer her business to a limited company.

(40 marks)

Basis of Assessment for Various Sources of Income

Louise

I would first advise that she look to page 599 of Personal Financial Planning (Gitman and Joehnk, South-Western, 2002), Part VI, Retirement and Estate Planning. Herein she will find details of which contributions to place now toward retirement planning. By leafing through this chapter, she will soon find herself holding focus to more of a peripheral view of what truly matters with investments and taxation.

By reading into this chapter, she will come to page 637, chapter 14, and get a better grasp on Sources and Costs of Annuity, where she will read that “annuities are administered by life insurance companies, and, for that reason, it should come as no surprise that they’re also the leading sellers of these financial products.” Keeping that in mind, I would advise her to next backtrack to page 619. Under the heading Taxes on Benefits, first she will see this next piece of information to keep in mind:

No longer are social security benefits a source of tax-free income. In 1984,

congress passed legislation to tax the benefits paid to upper-income beneficiaries.

Specifically, as the law presently stands, social security retirement benefits are subject to federal income taxes if the beneficiary’s annual income exceeds one of the following base amounts: $25,000 for a single taxpayer, $32,000 for married taxpayers paying jointly, and zero for married taxpayers filing separately.

Moreover, if that is not enough to alert her to that fact that social security will not suffice and that she had better become cynical and watch out now, soon in that same paragraph, “Thus, if for single taxpayers the resulting amount is between $25,000 and $34,000, 85% of benefits is subject to income tax.” Unless she desires to become trapped into a socialist system of standing in lines alongside crowds of irate, pessimistic, hopeless, fatalistic seniors, then she can submissively go on inattentively.

Otherwise, Louise can actively begin to reap her immediate and, what is more important here, long-term benefits due to her now. For the self-employed, various deductions, reliefs, and allowances exist to reduce a tax bill. For one, a small business proprietor / proprietress can deduct a malleable amount of the business expenditure to balance profits; however, this small business proprietor cannot deduct any private expenditure, nor can a small business proprietor claim special reliefs for certain capital expenditure, an exclusive payment to buy or improve an asset to assist in business maintenance.

This small business proprietor can usually get deductions, reliefs, and allowances concerning the current tax year, just as well as for the previous four years. Nonetheless, several deductions, reliefs, and allowances do exist with a shorter time limit for claiming for tax inclusion. Louise would could reap many benefits, as she is self-employed.

For fifteen years, as of 30th April 2009, Louise has solely operated a retail business. Since she carries on a trade or business by herself, as a sole proprietor or an independent contractor, she is self-employed; a trade or business is an activity carried on to accrue profit. Moreover, since Louise owns an unincorporated business by herself, she falls into the categorization of a Sole Proprietor.

In consideration of these terms, the facts and circumstances of each case determine whether an activity is a trade or business. As a general rule, ongoing efforts must be made to further the interests and profits of a business, but a business does not need to earn profit in the immediate here-and-now; only a profit-motive must exist. In the mind of any business proprietor, stable advancement and earnings would be optimal, but any business leader needs to learn the entire trade in order to proceed successfully.

Several retail outlets have accrued over this fifteen year period, under the sole proprietorship of Louise, and this year she has earned $150,000.00. Accordingly, she has paid a lump-sum contribution into this Revenue Approved Pension Scheme, so she is indeed entitled to tax relief. In order to obtain it, she must look to a superior financial planning website before this all-encompassing textbook concerning financial planning.

Louise will surely find optimal assistance, more importantly, in devolping a keen eye now by looking into Personal Financial Planning (Gitman and Joehnk, South-Western, 2002), a clear and concise text allowing for flexible course organization without dishonoring or undermining comprehensive illustration. Designed as a midlevel approach to personal financial planning, this text is written in a conversational style with many real-life examples. The life-cycle approach, practical applications, and decision-making focus are reinforced with expert advice, helpful tools, and real-life examples. First, I would remind her that she, as a self-employed business proprietor, is allowed to deduct most expenses in full; time to itemize.

To step outside of this Financial Planning text for just a moment, Certified Public Accountant James Maertin has a website which is structured in an effort at providing an inventory (a comprehensive check-list, considerably) of all things to consider while filing taxes. Within the text of this webpage [http://www.jamesdance.com/deductions.htm], upon addressing this issue of self-proprietorship, this line — “You are allowed to deduct most business expenses in full” — sets the stage for the itemized list to follow.

Reliefs Available on Incorporation of a Business

Within this webpage from J. Maertin comes a well-formatted record of possible tax deductions. Directly under the heading, Deductions, listed are direct links to the subheadings within this webpage (Business Expenses, Expenses you Cannot Deduct, Miscellaneous Schedule A Expenses, and Medical Expenses).

In addition to this list, an actual link to the “IRS Publication 587” is available:

http://www.irs.gov/pub/irs-pdf/p535.pdf].

Starting with the top three Business Expenses, Advertising and Promotion Expenses (self-employed), Books and Publications, which includes books, trade journals, newspapers, and publications for the applicable trade or profession, and next, Dues and Fees, including 1) Dues to a professional organization for people in your profession, 2) Union dues, initiation fees, 3) Regulatory fees for your profession, 4) Dues to chambers of commerce and similar organizations if the membership helps you carry out your job duties, and 5) Licenses paid to state or local governments.

After these fully detailed examples, Maertin elaborates just as fully on eleven more selections. In fact, some of these choices, such as Job Hunting Expenses, Miscellaneous, and Self-Employed Only have even more room to expand. Aside from these three examples, also included are these headings: Education and Research, Equipment and Supplies, Home Office, Internet, Travel and Transportation, Meals and Entertainment, Telephone Charges, and Uniforms and Gear; and then the opposite, Expenses You Cannot Deduct, which could come in handy just the same.

Next, I would advise that Louise look to Chapter 3 in Personal Financial Planning (Gitman and Joehnk, South-Western, 2002), Managing your Taxes. On page 121, under Maximizing Deductions, she will immediately learn to “Review a comprehensive list of possible deductions for ideas, because even small deductions can add up to big tax savings.” This book, too, like that webpage, is perfectly comprehensible; that is, these are all-inclusive resources. In this instance, the remainder of this one short paragraph sums up loads of information to come:

Accelerate or bunch deductions into one tax year if it will allow you to itemize rather than take the standard deduction. For example, make your fourth quarter estimated state tax payment before December 31 rather than on January 15 to deduct it in the current taxable year. Group miscellaneous expenses and schedule non-reimbursed elective medical procedures to fall into one tax year to exceed the required “floor” for deductions (2% of AGI for miscellaneous expenses; 7.5

percent for medical expenses). Increase discretionary deductions like charitable contributions.

The “imperative voice,” as opposed to the indicative (simple statement), inquisitive (question), or subjunctive (hypothetical statement contrary to fact), used herein keeps the point well directed and unambiguous with fewer words. This, and the abundance of significant issues covered are appreciated. Soon, Louise will learn which itemized discretions in which to focus and apply to her 1040.

Then, for sake of ease and quick manageability, I would refer her again to the internet. Aside from these accountable and academic websites that I advocate she look into immediately, there are surely many more websites for the self-employed to anxiously ponder through various deductions, reliefs and allowances that she can discover to reduce her tax bill.

Set out the issues which Louise should consider before deciding whether to transfer her business to a limited company:

From the Bernstein Law Firm, a limited liability company (LLC), which is also known as a company with limited liability (WLL), constitutes a flexible business enterprise arrangement that blends elements of corporate structures from partnerships. An LLC is not a corporation, but rather a business entity that serves as a form of unincorporated association. This hybrid business entity having certain characteristics of both a corporation and a partnership or sole proprietorship (depending the number of owners in conjunction) frequently, and incorrectly, has been referred to as a “limited liability corporation” (rather than “company”).

However, I would strongly press Louise to realize that limited liability does not imply that owners are always fully protected from personal liabilities. Courts can and will damage the corporate veil of corporations, these LLCs, when some type of fraud or misrepresentation is involved, and especially when the owner uses the company as a second-self, or perfect substitute or deputy.

The Bernstein Law Firm has more advice still. The primary characteristic that an LLC shares with a corporation is limited liability; the fundamental characteristic that an LLC shares with a partnership is the availability of pass-through income taxation, since this form of taxation is better suited for an individual company or chain of stores with a single owner, and frequently more flexible than a corporation. Regardless, an LLC is a quite legitimate and legal form of business company, which provides limited liability to its owners in the vast majority of United States jurisdictions.

Louise is aged 50 and single. Since 1994 she has carried on a retail business as a sole trader. Her trading profits as adjusted for tax purposes and after capital allowances, for the year ended 30th April 2009 were $150,000. The business is carried out from a number of valuable retail outlets, all of which are owned by Louise personally. These units have been acquired over a number of years since 1994 and their market values have increased considerably in recent years.

Apart from her single personal allowance tax credit, Louise is entitled to income tax relief in respect of $10,000, which she pays annually to a Revenue approved pension scheme. Louise’s personal living expenses and other financial commitments total $50,000 per annum (including the contribution of $10,000 to the Revenue approved pension scheme referred to above). Louise is considering transferring her business to a limited company and has asked for your advice.

REQUIREMENT: (a) Set out the issues which Louise should consider before deciding whether to transfer her business to a limited company.

Certainly, Louise cannot overlook taxes. She will best benefit when she gets in the habit of calculating the potential tax savings, including PRSI and levies, on profits that could arise from carrying on the trade through a limited company on the assumption that Louise’s annual living expenses financial commitments will be met by paying her an annual salary of €40,000 and the annual pension contributions of €10,000 will be made directly by the company to a Revenue approved pension scheme.

An employee’s income tax return is filed on a Form 11. Following the year of assessment, the due date for filing income tax return is 31 October. For example, the 1983 income tax return was due by 31 October 1984. Revenue also provides a useful guide to completing the form which is update annually. Two concepts, called Tax Bands and Tax Credits, entail the complete understanding in calculating income tax.

Fundamentally, the Irish tax system reimburses current expenditure programs; for example, universal free education (including third level), taxpayer funded healthcare, social welfare payments (e.g., old age pensions and unemployment benefit), and public capital expenditure (e.g., the National Development Plan).

The system of taxation in the Republic of Ireland is broadly similar to the system of taxation in the United Kingdom. This progressive system has little-to-no-tax on low earners, yet maintains a high-rate-applied to top earners. Based on income, or less-certain-allowances, employees pay-as-you-earn (PAYE), while holding true on taxes simultaneously. Corporation tax has a standard rate of 12.5%. And is among the lowest in the world. Much central government tax revenue originates from value added tax (VAT), excise duties, and other taxes on consumption.

Now let’s itemize. In order for me to clearly calculate the potential tax savings, including PRSI and levies, I must assume that Louise’s annual living expenses and financial commitments will be met by allotting her an annual salary of $40,000. The annual pension contributions of $10,000 will be made directly by the company to a Revenue approved pension scheme. This is based on profits that could arise from carrying on the trade through a limited company.

From what I’ve learned on Pensionsgreenpaper, Supplementary Pensions – Incentives for Retirement Savings, contributions to approved pension schemes by employers and employees are also exempt from PRSI into account any benefits paid as lump sums, subject to an overall pension fund cap of €5 million (indexed from 2007) introduced in the 2006 Budget and Finance Act.

Employee Contributions to occupational pension schemes are deductible for income tax and PRSI (including health levy) purposes and are tax relieved at the individual’s marginal income tax rate. Age related percentage limits apply to contributions as follows:

Age

Limit as Percentage of Payment Due

Under 30

15%

30-39

20%

40-49

25%

50-54

30%

55-59

35%

60 or Over

40%

Fundamentally, the Irish tax system reimburses current expenditure programs; for example, universal free education (including third level), taxpayer funded healthcare, social welfare payments (e.g., old age pensions and unemployment benefit), and public capital expenditure (e.g., the National Development Plan).

When configured in accordance with this system, Louise’s taxes can be determined accordingly. Since she is 50 years of age and single, her allotment will fall into the 30% bracket. Since Louise is unmarried, then her Personal Public Service (PPS) would not need to be altered. If she were married, however, in consideration of tax purposes, both marital partners would be treated as two single persons in the first year of marriage.

Then, if the tax this couple would pay as two single persons in that year is greater than the tax which would be payable, had that newly married individual been taxed as a married couple, then a refund of the difference can be claimed. Any refund due is from the date of marriage exclusively and will be calculated at the end of that tax year. A refund of tax for the year of marriage would normally only arise where a couple are taxed at different tax rates and one spouse could benefit from the unused standard rate band or from some of the unused tax credits of the other spouse. This is directly as stated with the Irish Tax and Customs website.

Louise is not married, so those rules would not apply and she would pay full taxation that all singles are obligated to pay (as noted). Moreover, tax relievable contributions are subject to an earnings cap of $262,382 per annum. This leaves the resulting forbearance at a maximum annual taxation of relieved employee contribution as limited to $114,337.11, or 30% of 262,382.

References

Maertin, James CPA. U.S. Tax Preparation Worldwide. [

http://www.jamesdance.com/deductions.htm%5D

http://www.hmrc.gov.uk/menus/aboutmenu.htm “HM Revenue and Customs: About Us.” Hmrc.gov.uk. Crown Copyright. 2005-04-18.http://www.hmrc.gov.uk/menus/aboutmenu.htm. Web. 30 July 2010.

Davis Esq., Tricia. Limited Liability Companies: Could your personal assets be at risk? Web. 30 July 2010.


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