February 20, 2003
Interview with John Fitzgerald, CPA
Much like the Titanic, we are inevitably approaching the deadly tax waters of April. In an effort to clear the fog on tax issues, we were able to obtain a bit of valuable time from John Fitzgerald, CPA, JD.
Mr. Fitzgerald is a Certified Public Accountant who represents a variety of clients, including many adult-oriented Internet companies. Mr. Fitzgerald obtained his Bachelors of Science in Accounting from San Diego State University and went on to become a Certified Public Accountant (CPA). He later attained his law degree from Thomas Jefferson School of Law. He is a member of both the American Institute of Certified Public Accountants, the California Society of CPAs, and the author of such programs as "Your Tax Cut Coach" and "Think Like The Rich." He has also served as an advisor to a national association of affiliated tax professionals representing over 50,000 clients and currently maintains two offices in Southern California.
AIL: Initially, how would you describe your role in assisting a client as a CPA?
Fitzgerald: I believe that Americans should be doing everything they can to maximize their revenue while minimizing their taxes. I believe that if people focus too much on minimizing their taxes, they'll miss out on opportunities that could make them a great deal of money.
AIL: Many CPAs will not take adult Internet businesses as clients. What is your position on such clients?
Fitzgerald: Over the years I've worked with a lot of terrific people in the adult Internet industry. The one thing I've learned is that they are just like any other business owner, they're trying to earn a living. The nature of their business is irrelevant to me.
AIL: Why use a CPA instead of one of the tax software programs on the market?
Fitzgerald: The old saying of, "garbage-in, garbage-out," is true when it comes to computer tax programs on the market. Unfortunately, no matter what information you put into the computer tax program, it will spit out a return that looks pretty good and the IRS will probably accept it. But if you're not a tax professional that has had the experience of working with thousands of clients, you just won't know where the deductions are. I've seen so many self-prepared returns which have been audited by the IRS simply because the person self-preparing the return just didn't understand how the IRS views returns and what they are looking for that could trigger an audit. Believe me, the added expense of paying a professional like myself is small when compared to the tax savings and the relief of not having to worry about an audit.
AIL: What are the differences between a C and S designation for a corporation and which, in your opinion, is the better choice for an adult-oriented company?
Fitzgerald: All corporations start off as C-corporations and then an election is made to have them treated as an S-corporation for tax purposes. For those small businesses that are just making enough to pay the bills, we generally recommend S corporation status because the owner is just starting out and is probably having to supplement the cash flow in order to pay the bills. As an S corp., we can deduct these excess expenses against the owners other income sources. However, once the business becomes profitable and begins building large amounts of cash, it makes more sense to be a C-corporation because we then have the opportunity to fund greater amounts into retirement plans and can provide the owner with more fringe benefits than would be available through an S-corporation.
AIL: Many states allow for the filing of single-owner limited liability companies. Is it true that the IRS is requiring the owners to file as sole proprietors and does this impact their tax situation?
Fitzgerald: The problem is that even though the IRS recognizes limited liability companies, they've never taken the time to implement regulations and Congress hasn't passed legislation to carve out special tax treatment for limited liability companies. As such, they have to be treated as either corporations, partnerships or sole proprietorships. Therefore, you're forced into fitting into one of these categories in order to file your taxes. Since single owners of limited liability companies can't operate as partnerships because they only have one person, they have to either be a corporation or a sole proprietorship. Since most don't formally take the step to formalize their limited liability company as a corporation for tax purposes, the only alternative left is to operate as a sole proprietorship. As such they have to pay self-employment tax on their earnings. Furthermore, many states have implemented limited liability company fees in order to generate more revenue. So careful planning has to be taken when setting up a limited liability company.
AIL: Many of our readers face self-employment taxes. Can you explain how the tax is applied, whether any of it can be recouped and the best methods for avoiding the tax?
Fitzgerald: Self-employment tax is taxed at a rate of 15.3% of the profit of the business. Therefore, if you want to reduce or avoid your self-employment tax you'll need to zero out the profit in your business, it's as simple as that! But, in order to reduce your profit, you'll need to legally increase your business expenses in order to bring your profit to zero. Besides the audit risk this creates, especially now that the IRS is closely scrutinizing any sole proprietorship with gross-earnings in excess of $100,000, you have to remember that certain expenses for the business owner aren't considered business expenses for the calculation of self-employment taxes. Retirement plans and medical expenses are just a few of these types of expenses, which aren't considered for self-employment tax calculations. As a sole proprietorship, you can legally reduce your self-employment taxes by hiring family members and providing certain fringe benefits to them such as medical reimbursement plans. This is all very tricky and has to be done correctly to pass IRS scrutiny.
Another option to reduce self-employment tax is to form an S-corporation for your business. But as I stated before, the compensation has to be structured correctly to avoid having the IRS re-characterize the S-corp. income as all self-employment income.
AIL: What are the biggest mistakes you see made by clients when they first come to you?
Fitzgerald: Almost every client I've come across has deductions which have been overlooked. Luckily the IRS allows us up to three years to recoup refunds from previously filed returns. We prepare hundreds of amended returns to help our clients get back large refunds. But the reason most people miss these deductions is because their tax-preparer never asked them the right questions and if they self-prepared the returns, they never knew the questions to ask in the first place.
But in summary, the biggest mistake that I find is that no one ever took the time to look at the big picture to see if things could be structured differently in order to reduce taxes. With all of the options available of retirement plans, corporations, partnerships, hiring family members, medical reimbursement plans, accountable reimbursement plans, etc., it is just too easy to correctly structure a business in order to minimize taxes.
AIL: Occasionally, we get inquiries from individuals that have not paid taxes the last few years. In such a situation, what options are there for the Webmaster?
Fitzgerald: There are two situations that commonly come up. People either don't pay taxes because they don't make enough money to file, or those that have to pay taxes but don't have the money to pay. Both types of individuals need the same solution and share a common result. They both need more money in order to improve their life-style and in the latter case, to pay their taxes, and both will result in more taxes to pay if more money is earned. The key to remember is for those in the latter category, the time to make an offer-in-compromise with the IRS is at the moment they are financially distressed. The IRS is much more likely to negotiate back taxes with someone in financial distress instead of when economic times are good.
AIL: If one of our readers receives an audit notice, how do you recommend they handle it?
Fitzgerald: The first thing they should do is to retain a tax professional. Remember, the IRS is an administrative monster and the people working for the IRS are looking for mistakes the typical person makes in complying with the record keeping requirements of the U.S. Income Tax Code. Therefore, unless you hire a professional, you won't know what the rules are and you'll be working in the dark. Not only will you miss deductions when you file your taxes, but your legitimate deductions will be disallowed simply because you didn't cross fill out the paper work right.
AIL: With the tax filing period coming up quickly, what should readers know about any new developments in reporting?
Fitzgerald: The IRS has recently liberalized depreciation rules allowing up to 30% depreciation in the first year of business in addition to normal depreciation and Section 179. Retirement plan contributions are another big area where the IRS has liberalized the rules. Furthermore, many of the IRS depreciation breaks took affect late in the 2001 tax filing season and many people filed their taxes without taking advantage of the new tax breaks. Knowing this, rather than amending the returns for 2001, the IRS is allowing business owners to catch up on the deductions in the 2002 tax filing. This can be a huge savings since it can also apply to business structures or large equipment. As for the retirement plans, not only have the retirement amounts greatly increased but also for people over 50, the IRS has allowed a catch-up provision to allow even greater contributions for the 2002 tax-filing season.
AIL: Many people in the adult Internet business work from their homes. What write-offs can they get for their home offices?
Fitzgerald: Home-based businesses can provide a great deal of write-offs. Between the home office deductions, hiring the family members, medical reimbursement plans, etc., a home-based business, which is property set up, can generate tens of thousands of dollars in deductions. In almost every case, we can show a home business owner how to restructure their finances in order to generate huge tax savings.
AIL: Is it true that claiming a home office raises your audit risk with the IRS?
Fitzgerald: It used to be, but not anymore. The IRS used to have very demanding rules for deducting a home office, which most people didn't understand and didn't qualify for. Now it's more liberalized and a home office doesn't present the risk it used to. Instead the IRS is now looking at any business that generates over $100,000 in gross sales. The IRS is now focusing in on the business owners which don't understand and comply with the very demanding record keeping requirements of the U.S. Tax Code. With the advent of computer tax programs, more and more people are self-preparing their taxes without the advice of a tax professional and therefore, don't fully understand the record keeping requirements demanded by the U.S. Income Tax Code.
AIL: If I started my online site this past November, can I report my losses on my taxes in 2003, carrying them forward, or am I just screwed?
Fitzgerald: It all depends upon the point in time that you're able to make money. All the expenses incurred up to the point in time where the web site can take orders are considered start up expenses. If incurred in 2002 but your web site isn't able to take orders until 2003, then you're unable to deduct these expenses until 2003. Then they will have to be added together and amortized over sixty months.
AIL: Is it true that using extensions to file my tax return later in the year will result in less chance of an audit?
Fitzgerald: It is true. Remember, the IRS is just like any other employer, they staff up for tax season. Then after the demand decreases, they lay off the extra help. With less eyes looking at your return your chances of being audited greatly decrease.
AIL:As we approach the tax-filing period, do you have any advice for our readers?
Fitzgerald: Get into see your tax advisor early. Listen to what your advisor is telling you and ask a lot of questions. Make sure your advisor is stimulating your creativity when it comes to your taxes. Sometimes, my clients need to take some Aspirin after leaving my office because the discussion becomes so intense regarding strategies and planning for the future. You can get a big jump on the 2003 tax season by using your 2002 tax preparation as an educational experience to find out what you should and shouldn't do to minimize your taxes. Also have your tax advisor look at your previously filed returns. A great deal of knowledge can be gained by reviewing those returns and some valuable advise on what you should do differently.
AIL: Thanks for the information.
If you would like to speak with John Fitzgerald regarding a tax-related issue, please contact us and we will refer you to him.
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