Wallis & Aho - Tax Services, Enrolled Agents

Frequently Asked Questions - Part 2.

Q: I am finalizing a divorce. I own and operate a picture framing business. My ex-wife is wanting to assign $10,000 of credit card debt to me (the credit cards are in her name only). Can I deduct the 12 monthly credit card payment totals (principle and interest) at the end of the year on schedule C if the divorce decree states that her credit card debts is my buy out of her half of the business?

After deductions my taxable net income is $9,500. Assuming the "buy out" is allowable and say for example the total is $2,000 a year, which is more advantageous:
1) Claim the $2000 as a deduction to reduce my income to $7,500? OR 2) File Bankruptcy (chapter 7) erase all my debt and increase my income to $12,000 a year? Is my out lay of cash (I'm not sure of the term) a year going to be the same amount whether I pay this credit card debt assignment or taxes? Is the amount of federal and self-employment tax going to be around $2000? Thank you.

A: I could probably answer your question better if I had some more information. What does the $10,000 actually represent? For example, if it represents a computer, or some equipment used in the business, then you are probably already deducting it through depreciation. If it represents things you bought for the business, then: did you deduct those things? and did you pay the credit card bill directly from the business, or pay it with money you took out of the business as draw?

Accounting for credit card transactions is tricky, and you will be in very good company if you did it wrong. Whatever you buy with a credit card is deductible when you sign the sales slip. When you make the credit card payment, you should not deduct it again. Any business people make the mistake of trying to deduct the credit card payments instead of the credit card charges.

Let's suppose you bought a machine for $5,000 and took a cash advance of $5,000 to pay the rent. When you did your tax return, you started depreciating the machine, and you deducted the rent. From your business standpoint, the $10,000 was deducted already, and your net taxable income was already reduced. However, since you didn't actually pay the $10,000 yet, the money left in the business was more than the than profit. So what did you do with the money? You probably spent it, which is OK, BUT it may mean that you borrowed money from your business.

When the credit card payments were made, what did you call them? Are you keeping track of what the business owes on the business charges? Or are the credit card balances an accumulation of all sorts of things, going back years? Basically, if you have deducted everything you charged for the business, then the credit card payments will not be deductible, although some of the interest might be. If you did not deduct the things you charged, then you have some accounting decisions to make, but you would be able to deduct them, possibly by amending returns. This will probably not be easy, especially if you filed joint returns and are not going to be married to that person any more.

Your reference to bankruptcy paints a broader picture - one in which it looks like the accumulated credit card debt probably represents an accumulation of money spent on living expenses that you couldn't afford. Try to follow me on this: You start a business by borrowing money. You use the money to pay the rent ($5000) and buy a machine ($5000). The business gets money: $20,000 from sales. The business pays expenses: $10,000 for supplies, etc., and $10,000 to you ( paid directly in cash, like a salary.) The business has no cash left, but the net profit for the business is 20,000 (sales) - (minus) 10,000 supplies - (minus) 5000 (rent) - (minus) 1000 depreciation on 5000 machine = (equals) $4000 (net profit). You do not deduct amounts paid to yourself on Schedule C; you pay tax on the net profit ($4000). That is all you need to do for your tax return, but your tax return (because it's a Schedule C) doesn't show that your business owes your credit card $10,000, or that your business paid you $6000 more than its profit. Now choose one:
a.) The business owes your credit card $10,000 and you owe your business $6,000
b.) The business owes nothing and you owe the credit card $10,000. Both are correct, but only corporations think like a. Without incorporation, 'you' and 'your business' is the same thing. The $10,000 owed to the credit card will not be a deduction when paid. The rent has been deducted, and the machine will be deducted over the next 4 years as you finish depreciating it. The debt really doesn't have anything to do with the business any more, except that the business should be allowed to deduct some interest. So the credit card debt you get from the divorce settlement won't really have anything to do with the business, no matter what the decree says.

ON THE OTHER HAND - If your business has been established a long time, has multiple assets, a positive net worth, etc., and the credit cards never had anything to do with the business anyway, THEN you would seem to have a situation where your wife is trying to establish a 'going concern value' or goodwill - an intangible asset that was created without money - and claim that you have to buy her half of it.

You can deduct amounts paid for goodwill by amortizing them over 15 years, BUT ONLY in a situation where the seller of the goodwill will realize capital gains. Transfers incident to divorce are specifically exempt from the sale rules. If you were buying goodwill from an unrelated person in this situation, the $10,000 would be taxable to the seller and you would be allowed to deduct $667 per year for 15 years. You would NOT be allowed to deduct the credit card payments. Since this is a divorce transfer, the $10000 will most likely not have anything to do with your business.

Now, about the bankruptcy issue: First let me remind you that I am not an attorney and I am not attempting, in any way, to offer advice on legal issues. From a financial standpoint, taxes are a percentage of income. Taxes are GOOD, because there MUST BE INCOME for there to be tax. A bankruptcy would mean that you don't pay the $10000 or the interest on it. It would mean several other things, as well. A deduction on Schedule C is generally worth about 30%. A deduction at 30% means that you pay $100 and save $30 on your taxes. If taxable net income on Schedule C = $9500 then Self-employment tax = $1342 and income tax depends on how you file. Single people get the first $7050 tax free (in 1999) so income tax would be about $368. It's important to see here that the most income tax you can save is $368. That's all the tax there is, so that's all you can save. The self-employment tax is what establishes your social security account. Decreasing your social security tax may seem like a savings, but in the long run, it's self-destructive. Social security is not only a hedge against future retirement costs, but provides important disability insurance’s for you and your family now.

If taxable income on Schedule C is reduced to $7500 then SE Tax = $1060, income tax 0, a savings of $650. If taxable income on Schedule C = $12000 then Self-employment tax = $1696 and income tax for a head-of-household with one dependent would be about $25. Yes, $25. If the dependent is a child, this return would generate a fair sized refund due to Earned Income Credit.

Please remember that we are not attempting to give specific tax advise on any specific situation, but merely attempting to provide general answers to general questions. We are not attempting to give accounting advice: we are not CPA's. We are not attempting to give legal advice of any kind; we are not attorneys. Enrolled Agents spEAk tax!

Q: How can i become a foreclosure agent. What would I need to do, and how would I go about doing that?

A: I'm sorry, but I'm not sure what you mean by 'Foreclosure Agent'. As in, banks foreclose on properties, so you want to be their agent? Doing what for them? Perhaps you could inquire at a bank or at a title company, or perhaps the courthouse.

Enrolled Agents, if that is why you're asking me, are Enrolled with the US Treasury Department. We are authorized by the Treasury to act as agents for taxpayers who may be having trouble with IRS. The treasury authorizes agents primarily to protect the government's interests against fraudulent claims and scams (enrolled agents were invented as a protection from carpetbaggers after the civil war).

To become an Enrolled Agent, one must be a US citizen, over age 21, I believe, and EITHER retire from service at IRS OR pass the comprehensive tax test given annually by IRS demonstrating proficiency in the areas of individual, partnership, corporate and fiduciary tax law, as well as an understanding of IRS procedures and ethical concerns. Enrolled Agents are also investigated by the Treasury Department to be sure they pay their own taxes, and are required to obtain continuing education and re-register every three years.
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