Bitcoin

If you have been keeping up with new fads, you have probably noticed the growing popularity of the Bitcoin.  But, what exactly is a Bitcoin and how does it work?  

Bitcoin is a digital currency.  Bitcoin can be used to pay for goods or services (if the vendor accepts that type of payment).  But, there is no physical currency.  Bitcoin is completely electronic, and payments are made and received over the internet using computers, tablets and smartphones.

To get Bitcoin, you visit an exchange on the internet and buy them with real money (US dollars, Euros, etc.).  Then you can use your Bitcoin to pay for goods and services from vendors that accept Bitcoin.  You can also transfer your Bitcoin to another user.  For example, if you and your buddy split a cab and he pays for the ride, you can transfer him Bitcoin to reimburse him for your share.   

Sounds pretty neat right?  It's like going to the arcade and cashing in dollar bills for game tokens, except the tokens do not physically exist and they can be used all over the world.  But, there are a few other considerations that make the concept not so simple.  

First, Bitcoin has a market value, similar to an exchange rate.  As of the writing of this article, according to bitcoinexchangerate.org, 1 Bitcoin is valued at $653.42.  This value will fluctuate according to the demand for Bitcoin, similar to a stock in the S&P 500.  This creates an environment where some use Bitcoin to pay for goods and services, while others are holding them as an investment.  According to this chart from CoinDesk, the value of a Bitcoin has fluctuated between $67 and $640 in the last year.  

Second, the IRS has issued a notice and FAQ's regarding the tax treatment of Bitcoin.  In the notice, the IRS states that virtual currency is treated as property similar to other property in the hands of the taxpayer.  This means that the exchange of virtual currency for goods and services could result in a gain or loss to the buyer.  For example, if I use one Bitcoin I paid $600 for to buy a set of golf clubs for $700, the seller must report the receipt of the Bitcoin as a sale at fair market value on the day of receipt ($700).  Also, I must report a $100 gain on the exchange of the currency because I used an asset that cost me $600 to buy something worth $700.  Using virtual currency is also subject to the tax reporting rules i.e. 1099's.  If I pay a contractor $1,000 in the form of two Bitcoin, I must issue that contractor a 1099 at the end of the year since the value of the services were more than the $600 1099 reporting limit.  

In closing, I am a big fan of modern technology and moving into a "greener" world.  The use of virtual currency makes it easier for buyers and sellers to transact business across borders without the worry of currency translation.  However, users of virtual currency should make themselves familiar with the ins and outs of their transactions and any related tax consequences prior to buying or selling.  To find more information about Bitcoin, I found their website very helpful.  

Fed to AR tax differences

All but seven states in the USA have their own form of individual income tax separate from Federal reporting required to the IRS.  Unlike the Federal system, which applies a uniform tax system to everyone regardless of what state they live in, states with an income tax all have their own way of doing things.  For example, some states start with Federal adjusted gross income (AGI) and work down to state AGI.  Other states require taxpayers to start from the beginning and calculate their state AGI on its own.  Still other states calculate income tax based on other factors, like Tennessee, which only taxes interest and dividends over a certain amount.

Arkansas has its own individual income tax system.  It is similar to the Federal system, but has intricacies that taxpayers should be aware of so that they don't over- or under-pay.

Married filing separately on same return

This is a filing status available to married Arkansas residents.  This form has two columns, one for the taxpayer and one for the spouse.  Joint income is divided between the two columns, but income allocated to one or the other goes in its respective column.  This is beneficial to married taxpayers where the taxpayer or spouse has a higher income than the other, because tax is calculated by taxpayer and spouse separately, then added together.  The tax is usually lower than if calculated on joint income, like a Federal return.

Income differences

There are several types of income that are taxed differently by Arkansas than at the Federal level:

• Social security benefits - not taxable to Arkansas
• Distributions from qualified retirement plans - if they are taxable, Arkansas allows a $6,000 reduction in the taxable amount, both for taxpayer and spouse.
• Capital gains - only 70% of net capital gains are reported on the Arkansas tax return.  However, up to $3,000 of losses can still be taken.
• Tax exempt interest - interest earned from municipal bonds is not taxable at the Federal level.  However, in Arkansas it is taxable unless it is from an Arkansas source.  For example, interest received from a New Orleans, Louisiana municipal bond is taxable in Arkansas, but interest received from a Little Rock, Arkansas municipal bond is not.  Neither is taxable on the Federal return.
• Depreciation differences - Federal depreciation benefits such as Section 179 and bonus are different at the Arkansas level.  Arkansas does not recognize bonus depreciation, and the Section 179 limits are much lower.  Therefore, income from S-corps, partnerships, or farms could be different for Arkansas than Federal.  Taxpayers should refer to an Arkansas-equivalent Form K-1 received from these entities.

Deduction differences

There are also several types of deductions that are different for Arkansas than on a Federal return:

• 529 plans - taxpayers that contribute to an Arkansas 529 plan for college savings are allowed an adjustment to income of up to $5,000 each for taxpayer and spouse.  The contributions have to be made during the tax year, and they must be to an Arkansas 529 plan (not just any 529 plan).
• State tax deduction - unlike the itemized deduction schedule for Federal returns, Arkansas taxpayers cannot deduct state tax payments on their Arkansas income tax return as an itemized deduction.  They can still deduct personal property and real estate taxes, but not estimated tax payments or withholding.
• Foreign taxes paid - instead of calculating the foreign tax credit like on the Federal return, all foreign taxes paid can be added in total as an itemized deduction on the Arkansas return.

Each state is different, so taxpayers should consult their tax advisor or their state department of revenue website for more information.

Straight cash

Cash basis taxpayers can make decisions during these last few days of December to improve their tax situation.

Cash basis taxpayers report income and expenses in the year that they actually occurred.  This allows cash basis taxpayers to defer income or accelerate expenses as the situation requires.

Income

Income must be recognized by a cash basis taxpayer when it has been constructively received and is available to the taxpayer.  If a taxpayer receives a check in January for work performed in December, that income is taxable in the next year.  However, if a taxpayer receives a check in December for work performed in December but puts it in a drawer and doesn't deposit the check until January, this is still income to the taxpayer because it had been constructively received and was available in December.  With this being the case, tax basis taxpayers can manage their cash inflows at year-end by sending out bills later to defer collection to next year, or requiring customers to prepay if more cash/income is needed.

Expenses

Expenses can be recognized by a cash basis taxpayer in the year paid or charged.  Yes, you read that correctly, charged.  The IRS will allow charges on a credit card as cash basis expenditures, even if the bill is not paid until the next month.  This provides some wiggle room for businesses that have cash flow concerns at year-end, because they can use a credit card to make purchases instead of cash.

Cash basis taxpayers can also use the end of the year to stock up on capital assets, especially right now due to the expiring Section 179 and Bonus depreciation provisions.

A word of caution: just because an entity is a cash basis taxpayer does not mean that every cash expense is deductible.  All expenses must still be properly substantiated and properly deductible.

Cash basis taxpayers should also consider their business operations when making year-end decisions on spending.  Yes, buying $5,000 of office supplies on New Years Eve will reduce the tax burden on the entity, but will that cash outlay penalize the business operations in January?

All I want for Christmas is a new bulldozer

Beginning in 2010, businesses have been afforded beneficial tax breaks via fixed asset additions and depreciation. These breaks are primarily Bonus depreciation and Section 179 expensing. Absent further action by Congress, Bonus is scheduled to go away and the 179 limits will be greatly reduced after 2013. Taxpayers can make an election to expense 100% of the cost of a new asset in the year of purchase under code section 179 of the Internal Revenue Code.  This method, commonly known as "179", has both cost and income limits.  In 2013, taxpayers can expense up to $500,000 under Section 179.  If the taxpayer's acquisitions exceed $2 million, their allowable expense is reduced and the taxpayer's 179 deduction cannot exceed taxable income for the year.  However, in 2014 the allowable expense drops to $25,000, with an acquisition limitation of $200,000.

Similarly, in 2013 taxpayer's can expense expense 50% of an acquisition up front, and then take normal depreciation on the other 50% for the year.  For example, taking bonus on a $1,000 asset would result in a $500 expense up front, plus regular depreciation for the year on the remaining $500.  It does not matter if the asset is new or used, there are no income or acquisition limits, and bonus can still be taken even if the taxpayer has no taxable income or the depreciation causes the taxpayer to have a net operating loss.  But, in 2014, bonus depreciation will "retire".

Now that we've discussed the rules, take a look at this bad boy.

This is a fine bulldozer made by Caterpillar, one of the largest heavy machinery manufacturers in the world.  Let's say that a taxpayer is in the market for this bulldozer and finds one at their local heavy machinery dealer with a list price of $250,000 (not actual list price, hypothetical only).  We can now look at how making that purchase in December 2013 vs. January 2014 will affect the taxpayer's situation.

If the bulldozer is purchased in December 2013, the taxpayer can either expense 100% of the cost assuming they had < $2 million in total additions and taxable income of at least $250,000, or the taxpayer can expense $125,000 of the bulldozer under bonus depreciation regardless of their other acquisitions and taxable income.

If the bulldozer is purchased in January 2014, the taxpayer will not be permitted to expense any of the addition under 179 because their acquisitions will exceed the limit.  The taxpayer will not be able to take any bonus depreciation either.

In this case, assuming a 39% tax rate, delaying the purchase to 2014 will cost the taxpayer savings in tax dollars of $97,500 if 179 could be taken, or $48,750 if bonus could be taken.

Although it is likely that Congress might pass some kind of extension to these depreciation rules, at this time there is no indication that the rules will be changed.  Taxpayers that have been considering making fixed asset additions, from bulldozers to printers to office furniture, should take advantage of the tax benefits in 2013 while they last.

The not-so-Alternative Minimum Tax, Part 2

A few days ago, this blog addressed the Alternative Minimum Tax (AMT) as it applies to individuals.  A little known fact is that businesses, like individuals, can be subject to the AMT.  Although the purpose is the same - assure that taxpayers with certain types of income and deduction structures pay at least a minimum amount of tax - the way in arriving at the AMT is slightly different.  This article addresses AMT as it applies to tax-paying corporations (C Corps).  It does not apply to passthrough entities such as S Corps or Partnerships, because AMT is calculated at the individual level.

Not all businesses are alike

Unlike individuals, some corporations are exempt from the AMT.  A corporation that qualifies as a "small corporation" is exempt from the AMT.  To be classified as a small corporation, the entity must:

• Be in its first year of existence, i.e. the current tax year is the year the entity began operations, or
• The company was treated as a small corporation for all prior tax years beginning after 1997, and
• The company's gross receipts did not exceed an average of $7.5 million for the preceding 3 tax years ($5 million if the entity has been in existence for 3 years or less)

After determining that the corporation is subject to the AMT, the taxpayer will complete Form 4626 with the Form 1120.  Form 4626 is organized similar to Form 6251 for individuals.  It begins with the corporation's taxable income, and then adds back / takes away various adjustments and preferences, such as:

• Differences in depreciation
• Differences in gains and losses
• Depletion
• Intangible drilling costs
• Adjusted Current Earnings adjustments (ACE)

After the corporation accounts for these adjustments and preferences, they arrive at their alternative minimum taxable income (AMTI).  Corporations are afforded an exemption if their income falls in a certain range, typically $40,000.  The AMTI is then multiplied by 20% to arrive at the AMT.

Just like individuals, if the AMT exceeds the corporation's regular tax, then they must pay the higher amount.

Because corporation's do not receive the same preferential treatment of gains being taxed at a lower rate like individuals, the biggest factor in a corporation's AMT calculation is depreciation.  A corporation needs to be mindful when capitalizing depreciable property that a large difference between the tax and AMT depreciation methods could subject the corporation to a higher tax rate.  Some assets, when capitalized using the 200% double-declining method of depreciation can only be depreciated using the 150% MACRS method for AMT purposes.  This will cause the AMT depreciation expense to be lower than the tax depreciation, resulting in an addition to taxable income in arriving at AMTI.