Death and Taxes

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Life is like a day. Sunrise, Sunset. A lot of us anticipate that we will die, later in life and if we are “fortunate”, life will give us notice before we do.

Unfortunately, we know, objectively, that is not always true. We all know someone that left us too early. I have had that happen 3 times, just since 6/7/18.

“Life is a movie. Death is a photograph” – Susan Sontag

When someone we love dies, our natural emotional response is grief. Taxes are the furthest thing from our mind-, and, as they should be. This is true for me and for many others that I know or have helped over the years. It is probably true for you, too.

Life dictates change, and even though we do not like it, sometimes our priorities need to change as well. There are things we must take care of, some of which can be time sensitive.

This blog was written to help others learn a little about death and taxes. In my experience, people are often very surprised (or shocked) to learn that tax returns may be required when someone dies. This blog is written in general terms because for many, state rules also apply. Ask your experienced Tax Professional for guidance, as needed.

There are three (3) possible IRS tax returns that may need to be filed after a death:

  1. The Final 1040
  2. Form 1041
  3. Form 706

 

  1. The IRS Final 1040 (Individual Income Tax Return)
  • Income received prior to and including death is reported on the decedent’s Final 1040 tax return
  • Upon death of the taxpayer a new entity, the estate, is created
  • A revocable trust becomes irrevocable upon the grantor’s death. From that point on, do not report income on the grantor’s individual income tax return, use Form 1041
  • The due date remains April 15 for calendar-year taxpayers
  • Your first step, prior to starting the final Form 1040, is to determine who is responsible to file and sign the return
  • If appointed, the representative files Form 56, Notice Concerning Fiduciary Relationship with the IRS
  • The person filing the return should write “DECEASED,” the decedent’s name and the date of death across the top of Page 1 of the tax return. Mail the form to the IRS Service Center for the area in which the person signing the return lives.

 

  1. Form 1041: Estate Income Tax Return
  • Income received after death is reported on IRS Form 1041
  • Notice that Form 1041 and Form 706 both use the word “estate” – learn to distinguish between the two (2) Forms; Form 1041 is for income (like the 1040)
  • An estate is comprised of all assets owned at the time of death, whether they are distributable through the probate process or an alternate way
  • The decedent and their estate are separate taxable entities; obtain an Employer Identification Number (EIN) for their estate or trust from the IRS website
  • The fiduciary of a domestic decedent’s estate, trust, or bankruptcy estate files Form 1041 to report:
  1. The income, deductions, gains, losses, etc. of the estate or trust
  2. The income that is either accumulated or held for future distribution or distributed currently to the beneficiaries
  3. Any income tax liability of the estate or trust
  4. Employment taxes on wages paid to household employees

 

Who Must File Form 1041:

Domestic Estate that has:  Gross income for the tax year of

  • $600 or more, or
  • A beneficiary who is a non-resident alien

 Domestic Trust  that has:

  • Any taxable income for the tax year
  • Gross income of $600 or more
  • A beneficiary who is a non-resident alien

 

Decedents Estates have an Exemption, but do not have a Standard Deduction.

Exemption:

  • Decedents’ Estate : A decedent’s estate is allowed a $600 exemption
  • Trusts required to distribute all income currently. A trust whose governing instrument requires that all income be distributed currently is allowed a $300 exemption, even if it distributed amounts other than income during the tax year

 

Form 1041 – Due Date

  • Form 1041 is due by the 15th day of the 4th month after the end of the estate’s tax year. For taxpayers choosing a calendar year, the due date is April 15
  • If you are preparing Form 706, you should prepare Form 706 at the same time as Form 1041 to determine where to report certain deductions

 

Tax

  • Like IRS Form 1040, the Estate Income tax rate for Form 1041 is progressive, but the rates rise very quickly. For example, the 2017 rate is 39.6% for income of $12,500 or more
  • The 2018 tax rate, inclusive of tax reform, is 37% for income of $12,500 or more

 

Important Form 1041 Takeaways:

Earlier in this post, I highlighted the following fragment in bold, any income tax liability of the estate or trust, and now, I will explain why I did this.

Uncle Sam, generally, may need to be paid before money is distributed to heirs. I am not providing you specific tax advice, nor am I providing you legal advice. However, I am sharing what I have learned via education and experience because this is something that a lot of people do not know and mistakes can be painfully expensive.

Cancelled debt, can trigger taxable income, which can result in an expensive IRS tax bill.

For example, one client received a 1099-C for student debt that was cancelled after the death of a family member. This triggered a large tax bill because of information shared earlier; i.e. a $600 exemption and a 39.6% tax rate. Exceptions, such as bankruptcy or insolvency, were not options.

Fortunately, recent tax reform changed this rule effective January 1, 2018:

Discharged of Student Loan Indebtedness

“The exclusion from income resulting from the discharge of student loan debt is expanded to include discharges resulting from death or disability of the student.”

A 1099-C may be issued for other forgiven deceased debt, such as credit card debt. Be prudent, and know your federal and applicable state rules before distributing assets to heirs. Your attorney may be a good resource to help guide you through this process.

 

3.  Form 706: Estate Tax Return

This form is used to report the transfer of assets from a decedent at the time of death.

The government imposes federal estate tax on the decedent’s entire estate. It is an excise tax on the right to pass property at death.

The Gross Estate includes the total value of the decedent’s interest in all property owned as of the date of death which can transferred due to the will or law. The form includes a number of schedules on which the estate lists the various assets or includes the expenses.

The theory behind the transfer tax system is to tax the value bequeathed to heirs. Since certain debts need to be paid and funeral expenses are customary, these amounts never become part of the inheritance. Because of this, the estate accounts for expenditures and debts in addition to assets.

Form 706 is due exactly nine (9) months after the date of death, unless the IRS has granted an automatic six (6) month extension of time.

For decedents who died in 2017, the executor of the Estate of every U.S. citizen or resident, files Form 706 for those:

  • Whose Gross Estate, plus adjusted taxable gifts and specific exemption is more than $5,490,000; or,
  • Whose executor elects to transfer the DSUE (Deceased Spousal Unused Exclusion) amount to the surviving spouse, regardless of the size of the decedent’s gross estate

Recent Tax Reform, the #TCJA, doubled the Estate Tax and Gift Tax Exemption, for estates of decedents dying and gifts made after December 31, 2017, and before January 1, 2026. The exemption increased to $11,180,000 for 2018.

 

Non-Resident Filing Requirements

Use Form 706-NA, to compute estate and generation- skipping transfer tax liability for nonresident alien decedents. If an individual who is a nonresident alien has a gross estate of property located in the United States in excess of $60,000, an estate return is required.

 

In closing, Ben Franklin is often credited for saying: “Tell me and I’ll forget. Teach me & I may remember. Involve me & I learn.”  I write because it is one more way I can help others from getting hurt financially.

I hope this blog helped you learn a little  about death and taxes. The information provided was written to provide a broad perspective; individual facts and circumstances need to be reviewed to determine what, if any, tax returns may apply for you (or for those that you love).

If I can answer questions or help you, please let me know.

 

Thanks for reading,

Deb

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. Deb thinks this is the fun part of tax because it makes a financial difference for her clients, their business, and their families.

She offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.

https://www.DeborahFoxCPA.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

The blog is provided as general information only and should not be considered a substitute for specific advice and services of a Certified Public Accountant, Enrolled Agent, or an Attorney

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Alphabet – Tax Terms & Tips

 

“Work Anywhere – includes an ice skating rink @ Hotel Del in Coronado, CA.

 

Almost a year ago, I presented my demo workshop titled “IRS Compliance and Strategy” for the University of Texas at San Antonio, Small Business Development Center (UTSA SBDC). My mentor, Ruben Lopez, MBA, and I identified the need for this class in our conversations. What I thought was important for a small business owner to know, Ruben, thought was important too. He suggested I create a class and if requested, present a demo, which I did, on 11/22/16. Since that time, I have taught this class, thankfully, several times for times for them and I look forward to teaching more.

While the students were learning from me, I, too, was learning from them. Their questions identified new topics that could be taught in class.

Every well-built house begins with a blueprint; I created this class as an IRS Business Basics- a blueprint for entrepreneurs and new small business owners. In today’s “Sharing Economy”, “small business owners” include independent contractors and freelancers. If you are just collecting your 1099-Miscellaneous forms and not tracking expenses, you are probably paying too much tax.

What we don’t know can often hurt us financially and education can prevent a problem.

This blog was created to help others learn, understand, and apply general income tax rules and procedures. I thought the alphabet format would be a fun way to teach tax terms & topics and hope you think so too.

A is for:

  • Accounting Method is how income and expenses are reported for taxation purposes:
  • Cash Method: Income is reported when constructively received (not earned) and expenses when paid (not incurred).
  • Accrual Method: Income is reported when earned (not necessarily received) and expenses when incurred (not necessarily paid).

B is for Basis of an Asset

  • Basis, in an asset, is its cost plus sales tax and other expenses incurred to acquire the property or to place the asset in service for tax purposes. This basis is used to figure depreciation, amortization, depletion, casualty losses, and any gain or loss on the sale, exchange, or other disposition of the property
  • The Initial basis can be increased or decreased for various items = Adjusted Basis
  • Maintain your basis for each asset to determine the accurate gain/loss
  • Retain supporting documentation for the life of the asset
  • Basis Limitation, is the limit on deducting losses, to the extent of the shareholder’s basis in the S Corporation or partner’s basis in the partnership

 

C is for Corporation

  • C-Corporation: “Double-Taxation” applies: the profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends
  • S-Corporation: Corporations that elect to pass corporate income, losses, deductions and credit through to their shareholders for federal tax purposes. Shareholders of S Corporations report the flow-through of income and losses on their personal tax returns

 

D is for Depreciation:

  • Depreciation is an annual deduction that allows taxpayers to recover the cost of property used in a trade or business or held for the production of income. The amount of depreciation depends on the basis of the property, its recovery period, and the depreciation method.
  • Depreciation Recapture: Amount of depreciation or section 179 deduction that must be reported as ordinary income when property is sold at a gain.

 

E is for: Estimated Tax

  • Method used to pay tax on income that is not subject to withholding (for example, earnings from self-employment, interest, dividends, rents, alimony)

 

F is for:

  • Failure to File (FTF) Penalty is 5%, of the additional taxes owed amount, for every month, or fraction of a month, the return is late, up to a maximum of 25%.
  • Failure to Pay (PTF) Penalty is the most common penalty issued by the IRS. 0.5% per month, or fraction of a month, up to 25%.

Tax Tip: Note there are 2 penalties. If you cannot afford to pay, at least file, and save yourself the cost of 1 penalty.

 

G is for Gig Economy:

  • Also known as the Sharing Economy or On Demand economy
  • File and Pay estimated taxes
  • Note that Self-Employment Tax is in addition to the Income Tax
  • Expect that a 1099-Misc will be issued to the IRS and to you if payments were more than $600/annually

 

H is for: “Hobby”

  • An activity is either a Hobby or a Business
  • An activity is, generally, presumed to be a Hobby if a profit is not earned in at least 3 of 5 taxable years
  • Tax deductions for hobby losses are limited to the income produced

 

I is for Independent Contractor

  • The general rule is that an individual is an independent contractor if you, the person for whom the services are performed, have the right to control or direct only the result of the work and not the means and methods of accomplishing the result.
  • The basic rule is that you must file 1099MISC whenever you pay an unincorporated independent contractor (sole proprietor or member of a partnership or LLC) — $600 or more in a year for work done in the course of your trade or business.

 

J is for Joint and Several Tax Liability

  • Married Filing Joint: Both you and your spouse are generally responsible for the tax and interest or penalties due on the return
  • This means that if one spouse doesn’t pay the tax due, the other may have to
  • Or, if one spouse doesn’t report the correct tax, both spouses may be responsible for any additional taxes assessed by the IRS

 

K is for Kiddie Tax:

Investment income of a child is taxed at the parent’s tax rate

 

L is for Limited Liability Company (LLC)

  • Notice that this is not a corporation
  • An LLC is created by state statue and is not an IRS filing status

 

M is for: Meals and Lodging:

  • You can deduct the cost of meals and lodging if your business trip is overnight or long enough that you need to stop for sleep or rest to perform your duties. In most cases, you can deduct only 50% of your meal expenses.
  • You can deduct entertainment expenses only if they are both ordinary and necessary and meet one of the following tests: Directly –Related test or Associated test
  • In general, you can deduct only 50% of your business-related meal and entertainment expenses

 

N is for Net Operating Loss

  • If your deductions for the year are more than your income for the year (line 41 of your Form 1040 is a negative number), you may have a net operating loss (NOL). You can use an NOL by deducting it from your income in another year or years.

 

O is for Ordinary and Necessary:

  • A business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business.

 

P is for Profit and Loss

  • Profit & Loss statements are required for small business loans, for a mortgage, and to determine tax owed for the IRS and/or your state
  • Review at least quarterly to determine if Self-Employment Tax & Estimated Tax payments are required

 

Q is for Quarterly Tax Reporting & Payments

  • The U.S. Tax system is “Pay as You Go” and generally not at the end of the year
  • Accounting records must be kept current to determine if quarterly payments are required

 

R is Refundable Credit

  • A Refundable tax credit means you get a refund, even if it is more than you owe
  • A Non-Refundable tax credit means you get a refund only up to the amount that you owe

 

S is for Self-Employment Tax:

  • 2017 Self-Employed Tax Rate, on net earnings of $400+, is 15.3%
  • 4% for Social Security and 2.9% Medicare Tax = 15.3%
  • For 2017, Social Security wages are capped at $127,200
  • Medicare Tax applies to all income; i.e. a wage limit does not apply

 

T is for Taxable Income

  • Gross income, minus any adjustments to income, any allowable exemptions, and either itemized deductions or the standard deduction = Taxable Income

 

U is for Use Tax

  • A tax on purchases made outside the state for use in the state. Residents are responsible for paying the tax on purchases for which no state sales tax has been charged. The tax applies to transactions that would be subject to sales tax if the purchase were made in the state.

 

V is for Vehicle

  • IRS Deduction for operating a vehicle for business, charitable, medical, or moving; track each separately- different rates apply
  • Standard Mileage Rates or the Actual Costs of using the vehicle
  • A taxpayer may not use the business standard mileage rate for a vehicle after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS) or after claiming a Section 179 deduction for that vehicle.

 

W is for Withholding (Federal Income Tax)

  • To avoid an Underpayment Penalty, estimate your 2017 tax liability, to see if you should adjust your withholding, or make an estimated payment before year-end

 

X is a tough one; X “Marks the Spot” or Solving for an Unknown:

  • You can fill in the blank on this one, or choose
  • X = Your Break Even Point
  • Unknown is your 2017 estimated tax liability

 

Y is for Year-End Tax Planning

  • There is still time to setup an appointment for year-end tax planning by December 31. Being in control of your finances & taxes is a great stress reliever.

 

Z is for Zero Based Budgeting (ZBB)

ZBB is a method to prepare cash flow budgets & operating plans. Each year these start from scratch and do not use incremental budgeting, in which past sales and expenses are assumed to continue. ZBB requires a systematic basis for resource allocation; cost-benefit analysis and priority ranking are part of the process.

 ©2017 Deborah Fox, CPA

 

Thanks for reading.

To your success,

Deb

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. Deb thinks this is the fun part of tax because it makes a financial difference for her clients, their business, and their families.

Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of e-mail, phone, virtual, and in-person communications.

http://www.DeborahFoxCPA.com 

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

The blog is provided as general information only and should not be considered a substitute for the advice and services of an attorney or Certified Public Accountant.

4 Step Process – What “Business Entity”?

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Tax and, to a lesser extent, Personal Liability, concerns often create a maze of confusion for those trying to decide what business entity should I choose?

I hope this blog reduces or resolves any confusion, creates clarity, and provides a solution for you.

This blog is intended to provide you a good “Birds Eye View” of your options and a systematic and analytical process to help you discover:

  • What “Business Entity” you may want
  • Why you want it, and
  • How much it will cost

As someone with both an accounting/tax and risk management background, I look at choices from two perspectives:

  1. The number side of me wants to find out if there is a way to save money.
  2. The risk management part of me wants to make sure we are protecting the money we have.

I also look at the “Cost VS Benefit” or the Risk/Return for decision alternatives.

Is the money spent worth the benefit received?

 This same process can work for you as you evaluate the pros and cons of your alternatives.

Before we look at the 4 Steps, it is helpful to see the “big picture” before diving into the details. “First, see the forest, and then see the trees”

Choosing a “Business Entity” involves choosing both a legal entity and also choosing the way you want your business entity to be taxed.

  • Legal Entities are created by state statues
  • Tax Classifications are created by the IRS

Legal Entities:

  • Sole Proprietor
  • General Partnership
  • Corporation
  • Limited Liability Company
  • Limited Partnership
  • Limited Liability Partnership

IRS Federal Tax Classifications are:

  • Sole Proprietor
  • Partnership
  • C Corporation
  • S Corporation

A cursory review of the two (2) lists clearly shows a mismatch; i.e. they are not “apples to apples”.

Hopefully, showing this to you “up front” will help you develop a discerning eye for the difference in terminology. Examples:

  • Corporations and Limited Liability Company’s are legal entities and not tax classifications.
  • A corporation has two tax classifications available to it, the C Corporation and S Corporation.
  • The Corporation is the legal entity and the C Corporation and the S Corporation are tax classifications.

If you get confused as you read through the details below, come back to the two lists to see which term fits where.

 Now, Back to the

Systematic and Analytical Process to Help You Decide:

  • What “Business Entity” you may want
  • Why you want it, and
  • How much it will cost

4 Step Process

  1. Take a Personal Inventory of your Business Needs
  2. Research & Understand your options
  3. Review the Cost VS Benefit of your possible choices
  4. Meet with a Certified Public Accountant (CPA) and an Attorney to help you finalize your decision

Factors to consider in your decision may include:

  • Your Objective
  • Your Industry
  • Short and Long term goals
  • Tax Implications
  • State law treatment
  • Protection for Personal Assets
  • Formation cost
  • Recordkeeping and ongoing maintenance requirements
  • Capitalization
  • Compensation
  • Allocation of Profits, Losses, and Distributions
  • Fringe Benefits
  • Rights and Duties of Business Owners
  • Management and Control
  • Transfer, Conversion, and Merger
  • Termination/Dissolution

Step 1:

Personal Inventory of your Business Needs:

  • What Do I have to Protect?
  • Liability exposure from your product, services, or location?
  • Am I operating this business by myself or do I have partners, shareholders or members?
  • What are my short and long- term goals?
  • Do I want to retain capital to pay for inventory or to fund growth?
  • Do I want to raise capital?
  • Do I want to establish business credit?

 

Step 2:

Research & Understand Your Options:

Broad Perspective:

Taxes and Personal Liability should both be considered as primary factors in your decision.

  • This blog will focus upon federal taxes; your state statues should also be reviewed. Don’t assume that your state law will follow the IRS. Do the research.
  • Personal Liability and the protection of personal assets, will be addressed within each entity type

The two types of federal taxation that are often considered in entity selection are income tax and self-employment tax.

Income Tax obligations vary depending on the legal structure and tax classification.

The most common forms of business are the sole proprietorship, partnership, corporation, and S corporation.

A Limited Liability Company (LLC) is a relatively new business structure allowed by state statute; it is not an IRS filing status.

  • With pass-through taxation, generally, no income taxes are paid at the business level. Business profit or loss is passed-through to the owners’ personal tax returns.
  • Corporations, on the other hand, are separate tax entities and are taxed independently from owners.

 

Self-Employment tax is required if your annual net earnings is more than $400.

As an employee, you know that money is withheld from your paycheck for social security and Medicare tax; you and your employer split this 50/50.

Self-Employed individuals must pay both the employer and the employee side of Social Security and Medicare tax.

The self-employment tax rate for 2017 is 15.3% of the first $ 127,200 of income and 2.9% of everything above that amount.

There is an income cap for the Social Security tax; the Medicare tax is not capped.

The Social Security tax rate is 12.4%; the Medicare tax is 2.9% (15.3% combined).

  • Self-Employment taxes are reported on Federal Form Schedule SE
  • Taxpayers can deduct 50% of their self-employment tax in determining their Adjusted Gross Income on Form 1040; the adjustment does not affect the amount of self-employment tax owed.

 

Detail Perspective:

Sole Proprietor: Flying Solo

Sole Proprietorships are an unincorporated business that is owned by one person.

Owner Liability?

  • Unlimited; A Sole Proprietor is always personally liable for the debts, obligations, and liabilities of the business

How Are Income Taxes Paid? :

  • Report business income or losses on your personal income tax return; the business itself is not taxed separately. File form 1040 and use Schedule C- Profit or Loss from Business.

Will I pay Self Employment Tax? –

  • Yes; file Schedule SE with your federal form 1040

Other Entity options for a Single Owner Entity?

  • Corporation
  • Limited Liability Company- Single Member LLC

 

Partnership: Two or More:

A Partnership is a relationship formed by 2 or more persons or entities that join together to carry on a trade or business.

Two primary choices:

  1. General Partnership – By definition, at least 2 General Partners each of whom manage the partnership
  2. Limited Partnership – A Limited Partnership has 1 or more General Partners and 1 or more Limited Partners. The General Partner manages the partnership; Limited Partners are typically passive investors.

 

Owner Liability?

  • General Partners, in a Partnership, are “jointly and severally” liable for the debts, obligations, and liabilities of the business
  • Limited Partners, in a Limited Partnership, have limited liability unless they take an active role in management; General Partners remain personally liable

How Are Income Taxes Paid?

  • Partnerships file an annual information return; file federal form 1065 and Schedule K-1 is used for the individual member’s profit and loss; Individual Partners file their personal tax information on Federal Form 1040 and Schedule E, Supplemental Income and Loss

Will I pay Self-Employment Tax?

  • Yes, if general partner
  • Generally, No, if limited partner

 

C-Corporation:

A corporation is a separate legal entity with a life beyond that of its owner.

For federal income tax purposes, a C corporation is recognized as a separate taxpaying entity. A corporation conducts business, realizes net income or loss, pays taxes and distributes profits to shareholders.

Double-Taxation applies: the profit of a corporation is taxed to the corporation when earned, and then is taxed to the shareholders when distributed as dividends

Owner Liability?

  • Corporations (C or S) – Shareholders are not personally liable for debts, obligations, or liabilities of the business

 

How are income taxes paid?

  • The C Corporation pays taxes on the annual net earnings and files federal form 1120

Will I pay Self-Employment Tax?

  • No, Self Employment Tax does not apply because payment for services is in the form of wages, which is subject to withholding for social security and Medicare tax

 

S-Corporation

  • An S corporation combines the limited liability of a C corporation with the tax treatment similar to a partnership.
  • You “elect” to become an S Corp by filing Form 2553 with the IRS within the 1st 75 days of the tax year that you want to operate as an S Corp.
  • The S status is only to elect to have all income /losses pass-through to the owners/stockholders and you must qualify to elect.
  • Failure to comply with IRS requirements will cause the S-Corp to lose its status.
  • State taxation of S-Corps vary – see your state rules. Some states treat S corporations, like C corporations, and impose an income or franchise tax.

 

Owner Liability?

  • S Corps limit liability to the same extent as C Corporations
  • Corporations (C or S) – Shareholders are not personally liable for debts, obligations, or liabilities of the business

How is Income Taxes Paid?

  • S Corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes
  • S Corporations are responsible for tax on certain built-in gains and passive income at the entity level
  • File S-Corp informational return on Federal Form 1120-S and use Schedule K-1 for the individual shareholder’s profit and loss
  • Shareholder-Employees are taxed on their salary income and on any profits distributed by the S-Corporation
  • Shareholder-Employees file Federal Form 1040 and Schedule E – Supplemental Income and Loss

 

Will I pay Self Employment tax?

  • Generally, no, this is why many Small Business Owners elect to be an S-Corp, if they qualify

 

Limited Liability Company (LLC)

State statues create a Limited Liability Company; owners are called members.

There are 2 primary types:

  • Single Member
  • Multi-Member

Owner Liability?

  • LLCs are state entities; the level of legal protection given to a company’s owners depends upon the rules of the state in which the LLC was formed

 

How are Income Taxes paid?

The tax classifications available to an LLC vary based on the number of members

  • All income, gain, loss, and deduction flow through to members unless the LLC is taxed as C-Corp
  • A Single Member LLC, by default, is a disregarded entity
  • A Single Member LLC can choose to be taxed as a “Corporation” *
  • A Multi Member LLC, by default is a Partnership
  • A Multi Member LLC can choose to be taxed as a “Corporation” *

 

Generally, when an LLC only has one member, the fact that it is an LLC, is ignored or “disregarded”, for the purpose of filing a federal tax return, and is treated the same as a Sole Proprietor.

 

If the only member is an individual, LLC income and expenses are reported on federal form 1040 and Schedule C, E, or F unless it files Form 8832 and elects to be treated as a C Corporation. *

 

A domestic LLC with at least two members is classified as a partnership for federal income tax purposes unless it files Federal Form 8832 and elects to be treated as a C Corporation *

An LLC can also elect to be an S Corporation, if they qualify*

The type of legal entity remains the same—only the tax classification changes to impact how the entity reports and pays taxes.

 

Will I pay Self Employment Tax?

  • Yes, Self-Employment Tax applies except if the LLC operates as C-Corp or S-Corp
  • Sole Proprietor and Partners both pay this tax. File Schedule SE with your federal form 1040

Step 3:

Determine the Cost VS The Benefit:

  • Each Option has it’s own “cost” and “benefit”. Understanding this helps you make an educated decision before you spend any money.
  • The options available to you vary by state and by profession. There is no one size fits all rule, for everyone, across the United States.
  • Visit your local SBDC, Service Corp of Retired Executives (SCORE), and Secretary of State website to find specifics for your area
  • Consider Tax (monetary) and Non-Tax benefits

Costs Include:

  • Filing Fees and Set-Up Costs
  • Annual Maintenance Fees & Services
  • Any State Entity Taxes on Gross or Net Income
  • Tax Return Preparation and Services through out the year
  • Cost, in terms of Time & Money: the amount of paperwork required, Board Meetings, Shareholder meetings, minutes, etc.,

For your state entity taxes, you could use an estimated amount of gross or net income for perhaps, 1, 3, and 5 years and then determine you estimated tax for each year. No, this is not a “real number”, but it does provide a useful illustration to help quantify your cost for alternatives

Benefits Include:

  • Potential Tax Savings
  • Peace of Mind because your personal assets are protected from business liability
  • Other intangibles 

 

Step 4: Meet with an Attorney/CPA to help finalize your choice:

Although a lot of information is included here, it does not cover everything that is important to understand.

Your preliminary research has probably increased your understanding, narrowed your choices, and also created new questions for you.

You could consider this 4 Step process as a good preliminary foundation for your discussions with your attorney and CPA; they can provide more details about income tax and legalities for your situation.

 

Wrapping Up

The entity selection process can seem like a maze of confusing options. I hope this information helped to remove some confusion and perhaps, make a small difference for you? If so, please let me know; I’d appreciate it. Thanks.

 

Thanks for reading.

To your success,

Deb

 

 

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth though education, strategy, and proactive tax planning. She is passionate about helping others. She teaches and also blogs to provide helpful information for individuals, independent contractors entrepreneurs, and small business owners.

Debbie offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of phone, e-mail, virtual, and in-person communications.

 

http://www.DeborahFoxCPA.com

 Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

The blog is provided as general information only and should not be considered a substitute for the advice and services of an attorney or Certified Public Accountant.