4 tax tips for new businesses

You’ve had enough of being a wage slave. It’s time to start your own business. That means it’s also time to consider the tax implications of becoming your own boss.

Grand opening yogurt shop

Here are four tax matters to think about as you plan your move from the corporate cubicle to your own self-employed suite.

1. Select a business structure. 
How you’ll run your business will affect your taxes. You have several choices.  The most common forms (and the federal tax forms required) are:

  • Sole Proprietorship (Schedule C or C-EZ as an attachment to your personal Form 1040, along with Schedule SE to pay self-employment taxes),
  • Partnership (Form 1065 and Form 941 for any applicable employment taxes),
  • Corporation (Form 1120 and Form 941 for any applicable employment taxes), and
  • S Corporation (Form 2553 to become an S Corp, then Form 1120S, 1120S Schedule K-1 and Form 941 for any applicable employment taxes).

Many business owners also elect to form a Limited Liability Company, or LLC. This is a business structure allowed by state, not federal, law. Check with your state if you are interested in starting a LLC.

Most states do not restrict LLC ownership, and so members may include individuals, corporations, other LLCs and foreign entities. There is no maximum number of members. Most states also permit single-member LLCs, which are, as the name indicates, LLCs that have only one owner.

The Internal Revenue Service treats one-member LLCs as sole proprietorships for federal tax purposes. This means that the LLC itself does not pay taxes and does not have to file a return with the IRS. As the sole owner of your LLC, you must report all profits (or losses) of the LLC on Schedule C and submit it with your 1040 tax return

2. Pay your business taxes.
There are four general types of business taxes. They are:

  • Income tax is due on the money your business earns. All businesses except partnerships must file an annual income tax return. Partnerships file an information return. See the business structures segment above for the tax form you’ll use.
  • Self-employment (SE) tax goes toward Social Security and Medicare. Just like when these payments are withheld from salaried workers’ paychecks, your SE taxes contribute to your coverage under federal retirement benefits, disability benefits, survivor benefits and Medicare’s hospital insurance benefits. Generally, you must pay SE tax and file Schedule SE (along with your Form 1040) when your net self-employment earnings are $400 or more.
  • Employment tax payments are required when you have employees. These include collection and filing of your workers’ (and your portion of) Social Security and Medicare taxes, federal income tax withholding and federal unemployment (FUTA). Employment taxes can be complicated, so it’s a good idea to hire a tax professional who specializes in this area. You can get an overview of employment taxes at the IRS’ special employment taxes Web page.
  • Excise taxes may be required if you manufacture or sell certain products, operate certain kinds of businesses, receive payment for certain services or use various kinds of equipment, facilities or products. The IRS website has a summary of the various types of excise taxes and forms required to file and pay them.

In most cases, the types of tax a business pays depends on the type of business structure selected.

You also may need to pay estimated taxes (Form 1040ES) on your business’ earnings. These taxes, paid four times a year, cover income and self-employment tax.

3. Obtain an Employer Identification Number (EIN).
Generally, businesses may need to get an EIN for federal tax purposes. Search “EIN” on IRS.gov to find out if the number is necessary. If needed, it’s easy to apply for it online

4. Choose an accounting method.
An accounting method is a set of rules used to determine when to report income and expenses.

The two most common are the cash and accrual methods.

  • Under the cash method, you normally report income and deduct expenses in the year that you receive or pay them.
  • Under the accrual method, you generally report income and deduct expenses in the year that you earn or incur them. This is true even if you get the income or pay the expense in a later year.

Whichever you choose, the IRS demands that you be consistent in its use. You can read more about accounting methods in IRS Publication 538, Accounting Periods and Methods.

If you find that’s a bit much, a good tax accountant can help you determine which method works better for your business.

You also should check out the IRS’ basics on starting a business, as well as a general overview of business owner, either as a one-person shop or a bigger business with employees at the tax agency’s Small Business and Self-Employed Tax Center.

You also might find these items of interest:

 


Source: http://www.dontmesswithtaxes.com/2017/08/4-tax-tips-for-new-businesses.html

Chicago-area soda tax angers consumers, while Philly’s similar levy may be driving those folks to drink beer

I’ve mentioned in few posts already this month that it’s hot. Here in Central Texas, we’re in a stretch of triple-digit temperatures that are breaking records every day.

That’s why our pantry is full of Cokes — that’s Texan for any kind of soft drink — and bottled water, since I like the carbonated kind. The refrigerator also is stocked with juices and, of course, beer.

Coca-Cola products in our pantry

Our increased liquid diet every summer means that we pay added sales taxes based on what beverages are in our grocery cart.

Soft drinks are subject to Texas state and local sales taxes, but sparkling water, as long as it isn’t flavored, is tax-free. Juices are taxed based on the percentage of juice in each container. Beer, of course, is hit with the state’s alcoholic beverage tax, as well as sales tax at the register.

So I understand the frustration that folks in Chicago and the rest of Cook County, Illinois, are facing now that they are paying a new tax on Cokes, I mean, sodas. (Or is it soda pop or just pop in that part of the Midwest?)

Delay confuses, angers beverage buyers: Customers expressed confusion and voiced their displeasure to cashiers on Aug. 2, the day that Cook County’s penny-per-ounce sweetened beverage tax took effect, according to a report in The Chicago Tribune.

The tax on sugary drinks went into effect slightly more than a month after its original July 1 effective date. The delay was due to a lawsuit filed by the Illinois Retail Merchants Association, or IRMA. A Cook County Circuit Court judge upheld the tax July 28 and set the new August date for the collection of the tax.

The tax should reduce soda and other sugary drink consumption, theoretically improving the health of Cook County residents, say health care advocates.

The real reason for the tax, however, is financial. The beverage levy was projected to bring in around $67.5 million this year and more than $200 million for fiscal year 2018.

However, the postponement of the tax’s implementation cost the county “at least” $17 million, according to Toni Preckwinkle, president of the Cook County Commissioners Board. As the lawsuit dragged beyond the original July 1 tax date, the county issued layoff notices to hundreds of public employees.

Confusing tax and shopping guidelines: As here in the Lone Star State, Cook County’s so-called soda tax applies to much more than Cokes and the like. Any nonalcoholic beverage that’s sweetened with sugar or artificial sweeteners is taxable.

And there are special considerations for juice, sparkling water, mixers and coffee drinks. The Chicago Tribune created a sweetened beverage tax guide for shoppers.

Welcome to my world, Chicago and surrounding suburban grocery shoppers.

Maybe it’s just because I’m used to sales tax on Cokes and other beverages, but my shopping for potables doesn’t change based on how much the state or city or county get on my liquid purchases. Rather, the hubby and I keep an eye out for sales and buy our beverages in bulk when our local stores offer good deals.

If the Cook County beverage tax holds — further legal action has been threatened — that’s probably the route that Illinois shoppers should take.

Change in consumer habits feared: Right now, however, some are threatening to shop outside the beverage tax jurisdiction to avoid the levy. I get it. But consider the time and gasoline involved in longer-distance shopping trips.

Such a change in shopping habits was one of the arguments made by opponents during debate of the Cook County soda tax. That concern was reiterated after the court ruling allowing the tax.

“Consumers should be concerned about how much higher their grocery bill is going to be,” said Tanya Triche Dawood, general counsel and vice president of IRMA, told The Chicago Sun-Times after the July 28 ruling. “This is an invitation for residents in this county to leave the county and shop elsewhere, which puts retailers at risk and, frankly, puts the county’s budget at risk.”

Is that just hyperbolic anti-tax talk? Maybe not.

Another major city that recently instituted a soda tax is finding that it isn’t working as hoped or planned.

Philadelphia’s costly beverage tax: A new study by The Tax Foundation finds that Philadelphia’s soda tax experiment is failing.

Philadelphia’s 1.5 cents per ounce excise tax on nonalcoholic sugar-sweetened and diet beverages took effect Jan. 1. Seven months later, about all that the tax has done is make the sugar-sweetened beverages more expensive in some cases than beer.

some of my favorite Texas beers

These are among my favorite brewskis here in Tejas. Unlike in Philly, a six pack of these beers is still more expensive than a 24-can carton of soft drinks.

Research by the Washington, D.C.-based tax policy think tank reveals that Philly’s city-wide so-called soda tax is 24 times the Pennsylvania excise tax rate on beer.

Prior soda tax data, according to the Philly study, suggests that high taxes on sugar-sweetened drinks are likely to drive consumers to consume more alcoholic beverages. That’s not necessarily the healthy benefits many are looking for such taxes to encourage.

Not a fiscal boon, either: The Tax Foundation also noted that Philly’s beverage tax collections, which were originally promoted as a way to raise money for prekindergarten education, are falling short of this fiscal goal.

In practice, Philadelphia awards just 49 percent of the soda tax revenues to local pre-K programs. This poor revenue performance threatens the sustainability of the programs it funds.

Compounding the problem, Philly’s soda tax revenues are likely below expectations due to consumer mobility.

And as threatened in the Chicago area, some City of Brotherly Love soda consumers may be heading to out-of-town stores to buy groceries, rather than pay the higher Philadelphia tax.

Or stopping off at the local package store to pick up a cheaper six pack of their favorite brews.

You also might find these items of interest:

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Source: http://www.dontmesswithtaxes.com/2017/08/chicago-soda-tax-angers-consumers-philadelphia-tax-driving-some-to-drink-beer.html

The Path to Enrolled Agent

If you’re looking for a career in the tax industry, set your sights high! While it doesn’t take much to become a tax preparer and start preparing taxes for the general public, earning a credential as an Enrolled Agent should be the ultimate goal.

Enrolled Agents are the only credentialed tax preparer and thus have instant credibility, they also have unlimited representation rights and the knowledge to prepare complicated tax returns (thus they earn more money).

Benefits of Becoming an Enrolled Agent 

While it may seem like a long road, becoming an Enrolled Agent is an attainable goal that can easily be tackled with the help of The Income Tax School. Our nationally recognized Chartered Tax Professional Certificate Program will not only provide you with the education you need to prepare taxes, you’ll learn everything you need to know to pass the IRS EA Exam. Here’s a guide to your path as an EA.

Step 1: Register for our Chartered Tax Professional Certificate Program Path to Enrolled Agent

Our Chartered Tax Professional Certificate program can be taken completely online. It includes a total of 60 lessons: 20 comprehensive lessons and 4 advanced courses (10 lessons each).

Step 2: Complete the Comprehensive Section

Once you’ve completed the 4 module comprehensive section, you will have the knowledge you need to start preparing individual tax returns for most U.S. taxpayers.

Step 3: Obtain a Preparer Tax Identification Number (PTIN) from the IRS

In order to prepare taxes for compensation, the IRS requires that you register with them and obtain a PTIN.

PTIN Requirements for Tax Return Preparers

Step 4: Take the 6 Hour AFTR Course

The IRS Annual Filing Season Program (AFSP) is an annual voluntary IRS tax training program for return preparers. It aims to recognize the efforts of non-credentialed return preparers who aspire to a higher level of professionalism. Those who pass earn a Record of Completion, are given limited representation rights, and are listed on the IRS Federal Tax Return Preparers Directory. This list is being marketed to taxpayers through a public education campaign that encourages taxpayers to select return preparers carefully and seek those with professional credentials or other select qualifications.

IRS Annual Filing Season Program (AFSP)

Step 5: Begin Preparing Taxes for Individual U.S. Taxpayers

You’re officially capable of preparing taxes for the general public! Seek employment with a tax firm in town or go out on your own!

Step 6: Continue Your Education

Keep working your way through our CTP course. You’ll take the Advanced 1 and Advanced 2 sections to learn how to prepare more complicated tax returns. Next, you’ll tackle the Small Business 1 and Small Business 2 and learn to help small businesses with their taxes.

Step 7: You’re a Tax Pro!

 

Once all courses are completed, you will have the knowledge you need to prepare taxes for anyone – and to start preparing for the EA Exam (called the Special Enrollment Examination). The entire CTP program can be completed in 8-16 months. As you work through the program, you can gain experience as a tax preparer. Once you’ve completed the program, you will receive a certificate from The Income Tax School that can be framed and displayed on the wall in your office.

 

Step 8: Take Our EA Exam Review

The Income Tax School offers an EA Exam Review through a partnership with ExamMatrix. ExamMatrix’s groundbreaking EA Exam Review Software has completely changed the landscape of EA Exam Review preparation. They offer an “Adaptive Learning” technology where students experience a personalized study program that accommodates your busy schedule.

Here are some study tips: How to Study for the Enrolled Agents Exam

Step 9: Register for and Take the SEE

Register for the SEE at Prometric.com. You will need to create an account and then schedule your exam.

There are three parts to this exam:

  • Part 1 – Individuals
  • Part 2 – Businesses
  • Part 3 – Representation, Practices and Procedures

Step 10: Apply for Enrollment at Pay.gov

Once you pass all three sections of the SEE, you will need to register as an Enrolled Agent. The application can be found at Pay.gov.

Step 11: Pass a Tax Compliance Check with the IRS

The Tax Compliance Check is basically a background check that begins once you submit your application (see Step 10). It takes up to 90 days.

Step 12: Spread the Word! You’ve become an Enrolled Agent! 

Congrats! You’ve gained the highest credential in the tax industry! Tell your clients and add that designation to everything: your desk placard, business cards, email signature, and LinkedIn profile.

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Source: http://www.theincometaxschool.com/blog/the-path-to-enrolled-agent/

Tax Court disallows $32,000 business expense deduction because taxpayer didn’t intend to turn a profit

Before you can write off your business expenses, you must show that you were indeed trying to turn a profit.

That basic business tax tenet was confirmed by a recent U.S. Tax Court decision.

Open for business sign going up in storefront

In a summary opinion, Special Trial Judge Daniel A. Guy, Jr., sustained the Internal Revenue Service’s accuracy-related penalty against Eric Zudak based on tax that was reduced by incorrect business expenses claims.

The judge held that Zudak wasn’t entitled to a deduction for expenses he paid for his film festival activity because he didn’t conduct the activity in a businesslike manner or engage in the activity for profit.

It’s not the first time the Tax Court has ruled this way.

Film festival for fun only: In this latest decision, issued June 19, court documents show that Zudak’s educational and professional background was in fine arts. After college, he worked for a multimedia company and later was a minor partner in a production company, for which in the spring of 2012 he managed a college film screening of the romantic the company made.

A few months later, in July 2012, court records show that Zudak organized US College Film Festival, LLC. He is the sole member of College Film Festival, or CFF, and did draft a business plan, prepare profit projections or conduct a formal market analysis for CFF.

The next year, he established a website for CFF where he posted material aimed at filmmakers, expressing his hope to “create a film festival where the interests of the festival directors would align with the interests and passions of working filmmakers, especially indie filmmakers.”

But he also stated in an online letter that during an early organizational meeting with the CFF team, “[E]veryone knew I was serious about 1) artistic expression, 2) the indie spirit and 3) the value of aggressive creativity. They also knew I didn’t give a damn about generating revenue, catering to the donors or preserving an imaginary legacy. I just wanted to bring together academics, artists and business development folks, in a way that created value for everyone involved.”

Not a good admission to make if you’re planning to deduct expenses for a so-called business.

Film festival losses mount: Nonetheless, he conducted a couple of college film festivals in 2013. In 2014, he filed his 2013 tax return, including a Schedule C for CFF. That sole proprietorship income tax form showed gross receipts of $690 and expenses of $32,747, resulting in a net loss of $32,057. Petitioner did not include a schedule of CFF’s expenses with his tax return.

As noted many times here on the ol’ blog, when you enter items on your tax return, it’s up to you to show that your claims are accurate. The Tax Court reiterated that in the Zudak case, noting, “The Commissioner’s determination of a taxpayer’s liability in a notice of deficiency normally is presumed correct, and the taxpayer bears the burden of proving that the determination is incorrect.

So, in claiming his expenses on his Schedule C, Zudak should have shown that they were legitimate business expenses.

Insufficient documentation: Instead, notes the court judgment, Zudak did not sufficiently refute the Internal Revenue Service’s contention that his activity was a hobby, not a business with the goal of turning a profit. In this case, argued the IRS, Zudak “is not entitled to a deduction for those expenses because he was not carrying on the film festival activity as a trade or business [as determined by the Internal Revenue Code].”

“If a taxpayer carries on an activity in a businesslike manner and maintains complete and accurate books and records, it may indicate a profit objective,” noted Judge Guy. “Keeping records only for purposes of preparing tax returns, however, is not indicative of a profit objective.”

Further, Guy found that:

Quotation-marks-quote“Although petitioner was able to gather bank and credit card records for the purpose of identifying expenses attributable to CFF’s activities, he did not maintain those records in a businesslike manner. Moreover, there is no indication that he maintained records with the aim of preparing profit projections, a breakeven analysis, or a formal budget. The record suggests that petitioner used the records only to compute CFF’s losses for tax purposes. This factor weighs against petitioner.”

Guy also evaluated Zudak’s earnings and loss claims against the other factors and circumstances the IRS used to differentiate a business from a hobby.

Overall, the judge found that erstwhile impresario “did not conduct the film festival activity in a businesslike manner and he did not engage in the activity with the requisite profit objective during the taxable year 2013. Consequently, we sustain respondent’s determination that petitioner is not entitled to a deduction for the net loss of $32,057 that he reported on Schedule C for the year in issue.”

He also must pay a penalty for his underpayment of tax based on his disallowed expense claims.

Hobby vs. business expenses: The bottom line for all would-be business owners is to follow know the tax code differences between a business and hobby. This week’s Weekly Tax Tip has more on the distinctions and the tax ramifications in both hobby and business situations.

And if, unlike Zudak, you find your original not-created-for-profit activity does indeed start to earn you some money, it could be worthwhile to officially turn your hobby into a business so you can claim its legitimate expenses against your for-profit income.

You also might find these items of interest:

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Source: http://www.dontmesswithtaxes.com/2017/08/tax-court-disallows-32000-business-deduction-because-taxpayer-didnt-intend-to-turn-a-profit.html

Taxpayer Advocate – FAQs are Trap for Unwary

The IRS National Taxpayer Advocate’s  7/26/17 blog post notes that FAQs “can be a trap for the unwary.” She notes:

my view is that the IRS should use FAQs when there is a need to provide guidance on an emergency or highly expedited basis. Examples include relief provided to victims of Hurricane Katrina or victims of the Bernard Madoff Ponzi scheme. However, my recommendation is that the IRS converts FAQs into published guidance as quickly as possible whenever an issue affects a significant number of taxpayers or will have continuing application. U.S. taxpayers are entitled to finality, and the prospect that the IRS may change its position and assess additional tax after a tax return has been filed in reliance on an IRS’s position is simply unfair.

“In addition, to ensure taxpayers understand the limitations of FAQs and other unpublished guidance, we recommend the IRS prominently display a disclaimer near such guidance that says something along the following lines: “Taxpayers may only rely on official guidance that is published in the Internal Revenue Bulletin.  Various IRS functions try to provide unofficial guidance to taxpayers by posting Frequently Asked Questions (FAQs) and other information on IRS.gov. Unless otherwise indicated, however, this information is not binding, and taxpayers may not rely on it because it may not represent the IRS’s official position.”[emphasis added]
The IRS recently reminded its examiners of that FAQs aren’t binding (see my 6/4/17 blog post).
Most FAQs are like IRS publications – just a summary of the law. It is the FAQs, such as those on the Offshore Voluntary Disclosure Program (OVDP), that are not summarizing binding guidance (statute, regulations, IRS rulings published in the IRB, court cases), that are problematic. They are not binding, but there is usually nothing else out there.
It is not just FAQs that are a concern. Chief Counsel Advice (CCA) are also issued where sometimes new interpretations of the law of noted. These are not considered “authority” for purposes of avoiding a taxpayer (Section 6662) or preparer (Section 6694) penalty. For example, CCA 201504011 on how unicap does not apply to a marijuana business in applying Section 280E that disallows deductions, but not cost of sales, for such businesses. Why wasn’t this issued as a revenue ruling or as regulations under Section 280E (which has no regulations despite its enactment in 1982 and its increased importance when states started legalizing marijuana in the mid-1990s)? There are also some Information Letters that have not binding underlying authority.
What do you think?

Source: http://21stcenturytaxation.blogspot.com/2017/08/taxpayer-advocate-faqs-are-trap-for.html

India’s demonetization effort produces more tax filers

India tax officials say their effort to reduce large stashes of illicit cash has led to markedly more tax compliance. Such efforts to get more taxpayers to be honest are ongoing globally, including by the Internal Revenue Service here in the United States.

Donation-wednesday-november-hindustan-checking-november-currency_743de176-c3ae-11e6-88a7-6a72017c5d0f

500 and 1000 Rupee notes that were recently demonetized by the Indian government.

It’s no secret that the Internal Revenue Service looks much more closely at business that are cash heavy.

The IRS, supported by other government studies, has found that cash intensive companies — which are, as the name indicates, businesses that receives a significant amount of receipts in cash — tend to have more under- or unreported income. When they don’t account for all their earnings, they pay fewer taxes.

Examples of such businesses, according to IRS guidelines, are restaurants and grocery or convenience stores that handle a high volume of small dollar transactions. Also on the IRS list are industries, such as construction or trucking, where independent contract workers are generally paid in cash.

Cash tax cheating is not limited to the United States. In fact, some countries are forcing their residents to go cashless to combat tax evasion.

It seems to be working, at least in India.

Cash as tax evasion tool: Last November, Indian Prime Minister Narendra Modi gave his citizens only a few hours to spend or deposit 500 and 1,000 rupee bills before they were abolished. These denominations, said the Indian government, were primarily held by individuals attempting to hide of illicit cash.

Financial transactions outside formal channels amounted, according to figures reported last year, to around 20 percent of India’s annual $2 trillion gross domestic product. By removing larger currency denominations from circulation could raise, it was estimated, an additional $30 billion in additional tax revenue.

After strong push back, Modi relented somewhat, giving holders of the large denominations a reprieve, moving instead to a more gradual conversion.

Regardless of the speed of the currency elimination, the ultimate goal of the so-called demonetization (or demonetisation in Indian English) measure is to clean up the subcontinent’s cash economy and associated black market that makes tax evasion too easy.

Fewer cash notes, more tax returns: Now, nine months later, India Finance Ministry says that P.M. Modi’s move to ban large notes and shift the economy from cash to “clean money” is working. It announced this week that the number of income tax returns has jumped by nearly 25 percent.

“Official figures show that the total number of returns filed as on August 5 stands at around 2.83 crore (28.3 million) up from 2.27 crore filed during the corresponding period of 2016-17,” reports the United Kingdom’s The Daily Mail. “This is an increase of 24.7 per cent compared to growth rate of 9.9 per cent in the previous year.”

That growth, according to Indian tax officials, is in large part thanks to a substantial number of new tax payers who have been brought into the tax system after demonetization.

The change on fiscal policy also is evident, according to tax officials, in the increase in direct tax collections.

Indian tax data show, per The Daily Mail’s report, showed advance tax collections of personal income tax (other than corporate tax) as of Aug. 5 showed a growth of about 42 per cent over the corresponding period in 2016-17. Similarly, personal income tax under Self Assessment Tax (SAT) grew at 34.25 per cent over the prior year’s corresponding period.

New tax, added investigations, too: Why such a turnaround? The Financial Times reports that the cash ban has been followed up by tax officials investigating individuals and businesses that deposited more than 200,000 rupees ($3,142) of the old currency notes in their bank accounts.

In addition, notes London’s leading financial newspaper, middle-class Indians are coming under greater pressure to comply with tax rules, as New Delhi undertakes reforms that will gradually make tax evasion more difficult.

“On July 1, the country launched a value added tax that is expected to force many small businesses into the tax net in order to continue doing business with larger, taxpaying firms,” reports The Financial Times.

Back across the pond: India’s effort to improve tax compliance is not surprising to U.S. tax officials, who have been battling a persistent tax gap. This is the amount of money the U.S. Treasury is owed, but which it’s been unable to collect.

In its April 2016 “General Explanations of the Administration’s Fiscal Year 2017 Revenue Proposals,” Treasury officials cited several proposals to reduce the tax gap, including expanded information reporting.

“Information reporting increases compliance by providing taxpayers with the information that they need to accurately complete their tax returns and by providing the IRS with information that can be used to verify taxpayer compliance,” notes the Treasury report.

It also gives the IRS documentation of taxable money received so that agents can double check the amounts entered by taxpayers on their returns.

The lack of such third-party reporting is why the IRS pays added attention to small businesses when it comes to audits. This is particularly true of the self-employed.

To avoid facing an IRS examiner, either in person or in a virtual conference, to discuss your tax return, take note of the documents you need to show that you’re complying with tax law.

Remember, when it comes to taxes, the IRS doesn’t have to prove you’re guilty. It’s starts from that assumption. You must prove to Uncle Sam that you’re doing what you legally should.

You also might find these items of interest:

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Source: http://www.dontmesswithtaxes.com/2017/08/indias-demonetization-effort-produces-more-tax-filers.html

Is your college scholarship taxable? Probably not

College students studying on campus via MGID and On Campus Market

Study up on ways to pay for your or your child’s college costs. Some student aid, like scholarships, typically are tax free. (Photo courtesy On Campus Market/OCM.com blog)

Here in Austin, fall 2017 classes at the University of Texas will begin on Aug. 30. But students must meet another important deadline on Aug. 18.

That’s the day that UT tuition payments are due, either paid in full or in installments. It’s a scenario playing out across the United States.

And it’s one that is a growing challenge.

The College Board’s most recent survey of college costs found that a moderate budget for an in-state public college for the 2016–2017 academic year averaged $24,610. A moderate budget at a private college was just more than twice that, averaging $49,320.

In most cases, students and their families trying to cover the high cost of higher education depend on a variety of funding sources, from savings to loans and educational tax breaks and work-study programs to financial aid like grants and scholarships.

Welcome way to pay: Scholarships can be particularly welcome. There are thousands out there — just Google “college scholarships” or check with your university’s financial aid office — ranging from a few hundred to thousands of dollars.

They are awarded based on merit and need. Many have broad eligibility criteria and cover expenses from tuition and fees to room and board, books, transportation and miscellaneous items.

The first question scholarship recipients ask is how will this money affect other college aid? College policies vary, but in most cases these funds that don’t have to be paid back will displace other types of student financial assistance.

Typically not taxable: But there’s better news for another scholarship question: Is the scholarship money taxable?

Your scholarship, fellowship or grant generally is tax-free if the following two conditions are met:

  1. You’re working toward a degree, undergraduate or graduate, at an educational institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities. Basically, you’re studying to get a diploma at a real school.
  2. You use the amounts you receive to pay for tuition and fees required for enrollment or attendance at the educational institution, or for fees, books, supplies and equipment required for courses at the educational institution. Again, the quick answer is that the money goes toward obtaining that degree.

These tax rules apply to both merit and athletic scholarships, fellowships and grants, including government-sponsored, need-based Pell Grants.

Note, though, the Internal Revenue Service says a scholarship or fellowship grant is tax free only to the extent that it:

  • Doesn’t exceed your qualified education expenses,
  • Isn’t designated or earmarked for other purposes, such as room and board,
  • Doesn’t require (by its terms) that it can’t be used for qualified education expenses, and
  • Doesn’t represent payment for teaching, research, or other services required as a condition for receiving the scholarship.

Opting/having to count it as taxable: While avoiding a tax bill on scholarship money is usually preferable, sometimes it might be worth counting the educational assistance as taxable income even if you don’t have to.

This could be the case if you qualify for an education tax credit. You may be able to get a larger credit by choosing to include some or all of the scholarship, fellowship or grant in your income.

And the IRS points out that some types of financial aid definitely are taxable. You must include in your gross income:

  • Amounts used for incidental expenses, such as room and board, travel, and optional equipment.
  • Amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant. However, you don’t need to include in gross income any amounts you receive for services that are required by the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program.

The Interactive Tax Assistant tool on IRS.gov can help you check whether and/or how much scholarship money is or isn’t taxable.

Reporting the financial aid: When you do have to report as income any portion of a scholarship, a fellowship or other grant that you received, add the amount to the “Wages, salaries, tips” line of your 1040, 1040A or 1040EZ form.

If the taxable amount wasn’t reported on a Form W-2, enter “SCH” along with the taxable amount in the space to the left of the “Wages, salaries, tips” line.

If you must file Form 1040NR or 1040NR-EZ, report the taxable amount on the “Scholarship and fellowship grants” line.

You can find more information the tax implications of scholarships and other education financial aid, as well as educational tax credits and other school-related tax breaks in IRS Publication 970, Tax Benefits for Education.

You also might find these items of interest:

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Source: http://www.dontmesswithtaxes.com/2017/08/is-your-college-scholarship-taxable-probably-not.html