To: John and Jane Smith
From: XXXXXX, CPA
Near Lakes City
Date: February 7, 2013
Dear Mr. & Mrs. Smith,
Thank you for coming to our offices and allowing us to review and discus your concerns regarding your tax questions. I have been assigned to reply to your questions and I have listed my recommendations below. After you both have reviewed these recommendations, please contact me so we can go over any additional questions you may have.
Mr. Smith’s questions:
1(a) How is the $300k treated for purposes of Federal tax income?
According to the IRC §61(a)(1), “Except as otherwise provided in this subtitle, gross income means all income from whatever source ...view middle of the document...
1(c) What is your determination regarding reducing the taxable amount of income for both (a) and (b) above?
A quick way to minimize the tax liability on your income of $300k is to review your expenses and determine if you had any additional expenses, relating to this client, during this tax year. Tax rules allow you to do this under the IRC § 162(a) which in part states, “Trade or business expenses (a) In general: There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business..”.,
One way I would suggest you can reduce your future taxable income is to establish a Simplified Employee Pension IRA (SEP). This is a retirement plan that you can establish as a self-employed individual. You will be allowed a tax deduction for contributions made to the SEP. A great benefit of this is that it not only can up to 18.6% of your net profits; also your contributions to SEP IRAs are immediately 100% vested. IRS Publication 560 covers the SEP IRA rules and I would be happy to discuss this further with you should you decide to establish an account.
Another way to reduce your future taxable income would be to reinvest some of your profits back into the business. Spending on capital improvements and worker training are examples of business expenses that decrease your profits and lower your taxes. Decreasing your profits by increasing your operating costs lowers your tax burden while you improve your business in ways that will eventually increase your revenues. This will result in more long-term profits, which you can then take or reinvest back into the business.
1(d) Is it more beneficial to continue leasing the business space or to buy the building?
I would recommend that you purchase the office building because this will allow you to have more tax benefits. If you purchase the building you will be able to take advantage of deducting mortgage interest, real estate taxes and you will be able to depreciate this property over a period of 39 years. Depreciation is the loss in value of an asset / building over time due to wear and tear, physical deterioration and age. Depreciation is treated as an expense and is a line item on your income statement but must be applied only to the building and not the land (since land does not wear out over time). You will be able to depreciate the building over a period of 39 years using the Modified Accelerated Cost Recovery System (MACRS). IRS Publication 946 contains the rules and guidelines governing depreciation of non-residential or commercial property.
Ms. Smith’s questions:
2(a) What are the different tax consequences between paying down the mortgage (debt) and assuming a new mortgage (debt) for federal income tax purposes?
Unfortunately, paying down your current mortgage and assuming a new mortgage will not result in different tax consequences for you or Mr. Smith. The only possibly benefit to...