memo to: | Mr. & Mrs. John smith | from: | carol johnson | subject: | tax issues | date: | September 29, 2012 | | | | |
Dear Mr. & Mrs. John Smith:
After carefully evaluating your tax issues my staff and I have come to the following conclusions on the questions you presented us.
1. John Smith tax issues:
a. How is the $300,000 treated for purposes of federal tax income?
The $300,000 you earned is considered earned income; therefore, it should be reported as gross income on either a Schedule C of your individual income tax return or if you have reported your company as being a LLC, you can file a LLC return.
b. How is the $25,000 treated for purposes of federal tax income?
The $25,000 would not be reported as income. The reasons why are that the $25,000 should have been classified as an expense (client advance) on the balance sheet at the time your received it two years ago. It would not have been reported as a deductible expense following the matching principle. In the current year when the $25,000 is reimbursed, the revenue minus the expense equal to zero. However, if you expensed it in the year it was paid, the $25,000 would be reported as income on this year’s income tax.
c. Determination regarding reducing the taxable amount of income for both (a) and (b) above?
You can make use of an LLC reporting as an S Corporation where wages that are paid to the shareholder may be less than the $300,000. The regular income tax rates will apply regardless, but this legal ploy can save some social security taxes which amount to an additional 15.3% (S-Corporations vs. LLC: Income Tax Savings Benefits, 2012).

You can reduce the taxable amount of income by fully funding a variety of retirement plans, such as IRAs, SEP-IRAs, profit sharing.
Take advantage of Section 179 (IRS, 2012), you can pay as many current expenses as possible.