Employee Owners and Accountable Plans

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A famous quote by Robert A. Heinlein is “When one teachestwo learn.”

In my experience, with almost every tax return I prepare or tax class I teach, I learn new ways to help others -financially. The missed opportunity for one can become Teachable Moments for others.

Single Member LLC- Transition from Schedule C to S-Corp:

Seasoned Sole Proprietors know they have a variety of “ordinary and necessary” business tax deductions available to them. These may be used long enough that they may just seem “normal” and like something that everyone getsall the time.

The Sole Proprietor may been rolling along, doing great, reached a certain level of net income and decided to change their tax filing classification from a Sole Proprietor to an S-Corp. They file form 2553, receive IRS approval, determine “reasonable compensation” and set up payroll for the Employee Owner.

Let’s pretend the above occurred in 2017 and in 2018 they asked me to help them with their 1st S-Corp tax return (1120S) and with their personal Form 1040 because the K-1 and other rules were new to them. I accept.

When preparing tax returns, it is always a good idea to compare the previous years returns with the current tax return because it helps to identify any significant changes. During this process, I identified 2 deductions used in 2016 that we could not use, retroactively for the 2017 return. For clarification, I am using the term “retroactively” because the 2017 tax year was closed, the W2’s issued, and we were now in 2018. They two (2) deductions identified were:

  • Self Employed Health Deduction
  • Home Office Deduction

 

New Tax Classification = New Tax Rules

A SMLLC, filing their IRS Form 1040 & Schedule C as a Sole Proprietor /Disregarded Entity wears one (1) “Taxpayer Hat” – their own

S Corporation Shareholder-Employees wear 2 “Taxpayer Hats”

  1. Employee who receives a W2 for their reasonable compensation earned during the year
  2. Shareholder/Owner may receive distributions from earnings and profits

Most of us know that we cannot co-mingle business and personal funds- they need to be separate.

  • The Schedule C taxpayer can use a business check to pay for a business flight for her business travel
  • The Employee Shareholder taxpayer needs to use a new process to obtain reimbursement for business travel

I understand this may sound strange, particularly if you are the only shareholder- “it is only me and it is all my money”. The IRS does not look at it like this- let’s use Starbucks as an example. Can a Starbucks employee write a business check to pay for their personal business expense? Usually – they cannot.

Employee Owners can use Accountable Plans to reimburse their allowable personal business expenses such as mileage, travel and meals. In my story, this was not an option for 2017 because the W2’s were already issued. However, this can be set up and used in the 2018 tax year.

  • S Corp Employee Owners must prepare expense reports and submit them to your Employer (company) on a regular basis
  • The S-Corporation issues a business check for the expense reimbursement which can then be deposited in the Employee-Shareholders personal account

My last blog, ‘Tax Reform and Employee Business Expense’, provided information and rules for Accountable Plans. Here are specific tips for the S-Corp Shareholder Employee:

Self-Employed Health Insurance Premiums:

One of the perks of being self-employed is that you can deduct the cost of health insurance premiums as an “Above the Line” deduction (Form 1040, Line 27).

“Above the Line” deductions are preferable because they can apply to everyone and are separate from choosing either to use the Standard Deduction or to Itemize Deductions.

To take this deduction, one of the following statements must be true:

  • You were self-employed and had a net profit for the year reported on Schedule C, C-EZ, or F. (Others may qualify too; the focus of this blog is the change from a Schedule C to an S-Corp)
  • You received wages in 2017 from an S corporation in which you were a more-than-2% shareholder. Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2
  • The insurance plan must be established under your business. Your personal services must have been a material in- come-producing factor in the business. If you are filing Schedule C, C-EZ, or F, the policy can be either in your name or in the name of the business
  • If you are a more-than-2% shareholder in an S corporation, the policy can be either in your name or in the name of the S corporation. You can either pay the premiums yourself or the S corporation can pay them and report them as wages. If the policy is in your name and you pay the premiums yourself, the S corporation must reimburse you. You can deduct the premiums only if the S corporation reports the premiums paid or reimbursed as wages in box 1 of your Form W-2 in 2017 and you also report the premium payments or reimbursements as wages on Form 1040, line 7

If the health insurance deduction cannot be used “Above the Line”, it is reported “Below the Line” on Schedule A, Itemized Deductions, as a medical expense, subject to the 7.5% of Adjusted Gross Income (AGI) limitation.

Home Office Deduction- for the convenience of the employer

  • S corporations may be able to use an Accountable Plan to reimburse expenses for the legitimate business use of the home. By doing so, the business can claim a deduction for necessary business expenses, while the taxpayer is allowed to exclude the reimbursements from income
  • Discuss your specific situation with your CPA or EA

This blog was written to help Small Business Owners know that there are many aspects to choosing a tax classification. It is so much more than “checking the box” or submitting the form.  If you want to learn more, reach out and schedule an appointment with your favorite Tax Professional. They, like me, love to help others save money through legitimate and timely deductions and/or tax planning.

In closing, if you are considering changing your IRS tax classification, I suggest you proceed with “informed caution”. Why? Generally, once an LLC has elected to change its classification, it cannot elect again to change its classification during the 60 months after the effective date of the election. Make sure you want to be “married that long” before you tie the knot and sign on the…dot. (Doted line)

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.

She offers free 30 minute no obligation consultations. We can discuss/resolve via a mix of 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 an Attorney, Certified Public Accountant or Enrolled Agent.

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Tax Reform & Employee Business Expense

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Before January 1, 2018, Employees, who itemized their deductions on Schedule A of Form 1040, could deduct their appropriate unreimbursed employee expenses that were greater than 2% of their Adjusted Gross Income (line 37 on Form 1040. This is no longer possible.

The Tax Cuts and Jobs Act of 2017 (TCJA) suspends all miscellaneous itemized deductions that are subject to the 2 percent of Adjusted Gross Income Floor. This change affects unreimbursed employee expenses such as uniforms, union dues and the deduction for business-related meals, entertainment and travel expenses in taxable years beginning after Dec. 31, 2017, and before Jan. 1, 2026.

While this new rule may change, currently this is the law and it may have a financial detrimental affect upon an employee’s financial “bottom line”; i.e. their spendable income, after tax. Lost deductions may mean a higher taxable income and tax expense. 2018 is about 5/12 over and now is the time to make adjustments – before 2018 is over and it essentially may be too late.

Options:

Employers can use an Accountable Plan to reimburse their employees, for allowable business expenses, without having this amount added as compensation to the employees W2.

With an “Accountable Plan”, the employer’s advance, reimbursement or allowance arrangement must include all of the following rules:

  1. The expense must have a business connection – the employee must have paid or incurred deductible expenses while performing services as an employee of the employer
  2. There must be an adequate accounting of these expenses to the employer within a reasonable time – expense report with receipts; some may qualify to use the Per Diem method
  3. Generally, the expenses must satisfy the substantiation requirement – the employee must report the amount, time, place, and business purpose. An easy way to remember this is to use the 5 “W’s:
  • Who? – Business Relationship
  • What? – Type of Expense
  • Where? – Place
  • When? – Date
  • Why? -Business Purpose

The employee must return any excess reimbursement or allowance within a reasonable time

  • Under an IRS “safe harbor” the following payments are considered to be made within a reasonable time
  • Advance Payments- given to you within 30 days prior
  • Substantiation of Expense – provided within 60 days
  • Return of Excess- done within 120 days of paid or incurred

 Substantiation must be done and the Excess Amount be returned within a reasonable period of time. If this time requirement is not met, the unsubstantiated or excess amounts are treated as reimbursements under a “Non-Accountable Plan”.

A “Non-Accountable Plan” is one that either does not require you to adequately account for your expenses or allows you to keep any excess reimbursements or allowances, over the expenses for which you did adequately account.

  • Employers report the reimbursements or allowances as part of your salary income in Box 1 on your W2, which is subject to FICA tax (Social Security and Medicare) withholding

 

In addition, even if your employer has an Accountable Plan, the following payments will be treated as being paid under an Non-Accountable Plan:

  • Excess Reimbursements
  • Reimbursements of nondeductible expenses

 

New Law and New Procedure?

The TCJA is in its infancy. It is less than 5 months old and many are still learning about it. This blog was specifically written to help provide information for both employees and employers. Financial Education, including tax rules, can make a difference and possibility prevent others from getting hurt financially.

Perhaps, for some, changing the compensation agreement might produce a Win/Win:

  • Employees might consider a “salary reduction” if the employer reimburses them for their business expenses that are no longer deductible as a miscellaneous itemized deduction
  • The employee benefits by having some or all of his expenses paid for and also reduces their taxable income and payroll tax
  • The employer benefits by reduced payroll tax and they can take a business deduction for the qualifying “ordinary and necessary” expense
  • Some Employees might decide they will do better by being an Independent Contractor where they could use Schedule C and deduct expenses as a Sole Proprietor.

When evaluating your options, remember to evaluate both federal and state rules before you act; i.e. Look before You Leap. 

If you are an employer, you can take the lead and help employees:

  • Be proactive and consider telling employees they cannot deduct employee related business expenses on their tax return, which may affect their 2018 annual tax bill. Tax planning can help and payroll withholding can be adjusted if necessary. Sooner is better than later.
  • Education helps to prevent unexpected financial surprises

 

Helpful Tip:

  • Remember, S-Corporation Owners can be both an Investor and an Employee Shareholder. S Corporations may want to consider an Accountable Plan for their Shareholder Employees to obtain reimbursement for their business related expenses such as mileage, travel, and meals.

  

In closing, it is always good to remember Ben Franklin’s famous quote “Beware of little expenses. A small leak can sink a great ship.” While the unreimbursed expenses may never sink a ship, evaluating options to identify cost savings is a smart thing to do. I understand most people do not like “tax”, but most of us like to save money. Right?

 

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.

She 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, Certified Public Accountant or Enrolled Agent.

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.

Get Started on the “Right Foot” Financial Planning for 2017

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When it comes to your finances, accounting, or tax rules, do you ever feel like a “Duck out of Water?”

If so, this post is designed to help you get started on the right foot, make your 2017 easier, and ideally, more profitable.

Here are 6 tips to help you get started:

1. Employ your money by considering how you can make it work for you:

One way to do this is to work with a tax accountant who can help you learn to use the tax rules to help you improve your financial results by decreasing your income tax expense. A tax software program may help you prepare and file your tax return, but it does not help you plan or make informed financial decisions.

A tax return is based upon the past. The best opportunity to make a difference is in the present.

Tax planning (and acting) may also help you save some money on your 2016 tax return – before you file. You can read the rules, read some of my others blogs, or ask someone for guidance.

 

2.  Self-employment comes with both a lot of perks and responsibilities; this is particularly true for income tax rules and obligations.

The IRS defines Earned Income as all taxable income and wages from working either as an employee or from running or owning a business (net earnings from self-employment).

Last year at tax time, a lot of people were caught by surprise because they had not considered how their UBER or other self-employment income would be taxed. It is important to know the rules to avoid penalties for either not reporting on time and/or for not paying income tax on time.

Use the following information to avoid penalties, price your products/services and to plan your budget:

IRS Business Basics – Compliance – “Must Do”:

  • The U.S. tax system is “Pay as You Go, generally, not at the end of the year
  • If you owe the IRS more than $1K during a year, it is not ok to wait to pay
  • Quarterly Reporting & estimated tax payments are required to avoid late payments, interest & penalties
  • Accounting records must be current to determine – if you need to pay quarterly tax
  • Generally, Calendar Year Due Dates are 4/15, 6/15, 9/15, and 1/15 for the previous year
  • If you don’t pay enough tax by the due date of each of the payment periods, you may be charged a penalty
  • Individuals (Sole Proprietors, Partners, S-Corp Shareholders) need to pay estimated tax if they owe $1,000+
  • Corporations need to pay estimated tax if they owe $500+
  • 2 Possible Penalties: Failure to Fail and Fail to Pay on time – If you can’t pay, at least file; prevents 1 penalty
  • Estimated tax is used for: Income Tax; Self-Employment Tax and Alternative Minimum Tax
  • Reconcile payments on your annual tax return

 

 3. Self-Employment Tax of 15.30% is required on Annual Net Earnings of $400+ – “Must Do”

  • You, need to know “Up front” to budget for cash expense and to consider for product/service profitability
  • Sole Proprietors & Independent Contractors must pay both the employer and the employee side of Social Security and Medicare taxes
  • The 2016 SE tax rate on Net Earnings is 15.3% (12.4% social security tax plus 2.9% Medicare tax)
  • The Self-Employment tax rate is 15.3% of the first $118,500 of income and 2.9% of everything above that amount
  • If you also work as an employee, be careful that you do not overpay your Social Security tax. The $118,500 applies to your combined wages, tips, and net earnings
  • Sole Proprietors can deduct ½ of this cost on Form 1040-Line 27, the deductible part of self-employment tax

 

  1. QuickBooks Self-Employed can help you with your business recordkeeping and to determine your estimated tax:

This product is a little less than 2 years old and was designed to simplify the basics for those who are self-employed, own a small business, and who do not have employees (payroll) or inventory. Good examples include realtors and independent contractors.

The program allows you to track business income and expenses and to make tax time simple by capturing all expense deductions, including tracking business mileage. The program also estimates your required IRS quarterly tax payments, lets you separate personal and business expense and create and send invoices on the go.

The cost of $10 or less per month makes it affordable. If you work with a Certified QuickBooks ProAdvisor Accountant, they may be able to provide you a 50% discount on the program cost for your 1st year of use. Reach out to them and ask. If so, they can send you a link to help you get started at the discounted rate.

 

  1. MileIQ is an easy way to track your mileage for expense purposes.

The app is an automatic mileage tracker, which can improve accuracy and add convenience.

2017 rates are:

  • $0.535 for business
  • $0.170 for medical or moving
  • $0.140 for charity

Alternatively, you can use actual expenses incurred.

Either way, the IRS requires documentation, which includes both the beginning and ending mileage, where you went, and why. If you have not been doing this, step outside and record your odometer reading today. That number can provide a good estimate to end your 2016 tax year and to begin 2017.

Also note that if you used accelerated depreciation for your vehicle and used the Section 179 deduction, you cannot revert and use the standard mileage rates.

 

6. Don’t Believe, “Don’t Worry, it’s a Write-Off:

There are a lot of rules for what is an acceptable deductible business expense that apply for who, for what amount, and when.

Following are some general terms that will help you get started in learning IRS terminology and rules.

Note that what is an acceptable taxable deduction in your business may not be acceptable for my business. The “tool belt” is different for a carpenter than for an accountant.

  • Use IRS rules to decrease income tax expense
  • Business Income can be reduced by “ordinary and necessary” expense:
  1. Ordinary expense = Common or Accepted in your trade or business
  2. Necessary expense= Helpful or Appropriate for your trade or business
  • Operating Expense = expense incurred under normal business operations (rent, utilities, insurance, payroll)
  • Capital Expense= benefits more than 1 year (property, plant & equipment)
  • Capital Assets are generally expensed over a period of time by using depreciation and amortization rules
  • Depreciation and Amortization are both a Non-Cash expense
  • They reduce Net Income on an Income Statement, but do not reduce the Cash account on the Balance Sheet
  • The expense can either be based on standard or accelerated rules.
  • Section 179 is an example of an accelerated expense i.e. take a larger deduction in earlier years. Be careful here because you can also be subject to “recapture rules”.
  • This list is not exhaustive nor does it include all the rules. The information is shared to provide general concepts and to plant seeds for future learning.

 

I hope these tips to help you get started on the “right foot” and help you feel less “like a duck out of water”.

We all have gifts we can use to make a difference for each other.

I hope this blog post might have made a small difference for you.

 

Thanks for reading.

To your success,

Deb

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth. She can help by being your financial compass while you captain your ship.

Deb 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.debfoxfinancial.com

http://www.DeborahFoxCPA.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

Perspective: A Number Story

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Our observations can be limited by our experience.

For example, recently an architect gave me suggestions for elements to include in a new website that I will launch soon for DeborahFoxCPA.com. His design-eye expertise is invaluable to me. I told him, “You can see things that my eyes do not. I look, but do not see the same detail as you do.” His reply was priceless, “Of course honey this is why we help each other – you see numbers I can’t see LOL.”

Perspective matters.

Numbers tell a story – in our financial statements and on our tax returns. I look for opportunities to make a difference in the story and so can you.

As we approach the end of the year, now is a great time to review the “Big Picture”.

You are the Chief Financial Officer of your home or for your business. You are in the driver’s seat.

Step away from thinking about “working in your business” and focus upon “working on your business”. Think about what you could do to make improvements. Focus upon strategy. Not compliance.

Compliance is filing a tax return. It is what we have to do to comply.

Strategy is about making a difference before you file the return or issue the next financial statements.

Here are 3 ways you can make a difference in your financial story:

  1. Review your financial performance:
  • Are you allocating your budget resources (time and money) for the best use?
  • Compare budget to actual results
  • Compare year-to- year results; identify what changed. Why?
  1. Use financial ratio’s to uncover patterns:
  • Are there areas or activities that are underperforming?
  • Do certain activities provide little value or return on your investment?
  • Can you change your mix to provide more value for you?
  1. Generate new insights:
  • Can you find new opportunities?
  • Can you make changes that would reduce your risk?
  • Could some help from a different perspective find value for you?

 

Henry David Thoreau said, “It is not what you look at that matter’s, it’s what you see.”

What I could see, changed, after I reviewed the architect’s suggestions for my website. Likewise, his perspective changed, too, after I helped him.

We all have gifts we can use to make a difference for each other.

I hope this blog post might have made a small difference for you.

 

Thanks for reading.

To your success,

Deb

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth. She can help by being your financial compass while you captain your ship.

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.debfoxfinancial.com 

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA

Can the IRS help you recover from Mother Nature?

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Mother Nature created a life changing financial effect upon many American financial lives.

  • Since 6/11/16, there have been 6 Major Disaster Declarations in 6 different states: Texas, Oklahoma, West Virginia, Montana, Wisconsin, and Louisiana
  • During the same period of time, there have been numerous Fire Management Assistance Declarations in multiple states, mostly in California and most recently in Washington

If I could, I would, restore your homes to their original condition- with a wave of a Faerie wand or a twitch of a nose. Unfortunately, I cannot do that.

What I can do is to use my commercial property & casualty experience and my tax knowledge, to create this blog and hopefully provide you information you can use, to help you recover from a financial loss.

Damage caused by Mother Nature = Casualty Loss:

A casualty loss can result from the damage, destruction, or loss of your property from any sudden, unexpected, or unusual event such as a flood, hurricane, tornado, fire, earthquake, or volcanic eruption. It does not include normal wear and tear or progressive deterioration (termite damage).

  • For those that had a property loss due to fire, an insurance policy may have helped you recover some of your financial loss
  • For those that had a property loss due to a flood, financial help from an insurance company may not be  available; FEMA or others might help

 

In addition to insurance or FEMA assistance, the IRS tax rules may provide you some tax relief:

  1. Allow you to deduct a portion of your unreimbursed loss on your individual tax return
  2. Allow you to use a Net Operating Loss to change past tax returns or to use that loss on a future tax return

 

Perspective:

  • Casualty Losses are required to be reported on Schedule A as an Itemized Deduction
  • For practical purposes, Itemized Deductions need to be greater than the Standard Deduction to provide you a tax financial benefit
  • Is your loss more than the amounts shown below?

 

2016 Standard Deductions:

  • $6,300 for Single and for Married Filing Separate (same as 2015)
  • $12,600 Married Filing Joint (same as 2015)
  • $9,300 Head of Household (was $9,250 for 2015

 

Planning Tip: “Details create the big picture “ – Samuel I. Weill

  • The IRS requires documentation for tax deductions; start to gather and prepare now
  • The only way to see what will work for you is to gather, evaluate and decide
  • If you have questions, reach out and ask, including from me

 

Individual Tax Deduction Rules:

  • Generally, you may deduct casualty and theft losses relating to your home, household items, and vehicles on your federal income tax return
  • You may not deduct casualty and theft losses covered by insurance, unless you file a timely claim for reimbursement and you reduce the loss by the amount of any reimbursement or expected reimbursement

 

If your property is personal-use property or is not completely destroyed, the amount of your casualty loss is the lesser of:

  • The adjusted basis of your property, or
  • The decrease in fair market value of your property as a result of the casualty

 

If your property is business or income-producing property, such as rental property, and is completely destroyed, then the amount of your loss is your adjusted basis.

 

Tip: Adjusted Basis =

  • The adjusted basis of your property is usually your cost, increased or decreased by certain events such as improvements or depreciation
  • For property you buy, your basis is, generally, the cost to you
  • For property you acquire in some other way, such as inheriting it or getting it as a gift, you must figure your basis in another way- see Pub 551

 

Claiming the Loss:

  • Individuals are required to claim their casualty and theft losses as an Itemized Deduction Form 1040, Schedule A
  • For property held by you for personal use, you must subtract $100 from each casualty or theft event that occurred during the year after you have subtracted any salvage value and any insurance or other reimbursement
  • Then add up all those amounts and subtract 10% of your adjusted gross income from that total to calculate your allowable casualty and theft losses for the year
  • Consider using your 2015 Adjusted Gross Income (AGI) as a benchmark – (the last line, on the 1st page, of your 1040 tax return)
  • Report casualty and theft losses on Form 4684, Casualties and Thefts
  • Use Section A for personal-use property and Section B for business or income-producing property
  • If personal-use property was damaged, destroyed or stolen, you may wish to refer to Pub 584, Casualty, Disaster, and Theft Loss Workbook (Personal-Use Property)
  • For losses involving business-use property, refer to Pub 584-B, Business Casualty, Disaster, and Theft Loss Workbook
  • These workbooks are helpful in claiming the losses on Form 4684; keep them with your tax records

 

When to Deduct:

  • Casualty losses are generally deductible in the year the casualty occurred
  • However, if you have a casualty loss from a federally declared disaster that occurred in an area warranting public or individual assistance (or both), you can choose to treat the casualty loss as having occurred in the year immediately preceding the tax year in which the disaster happened, and you can deduct the loss on your return or amended return for that preceding tax year
  • Claiming a disaster loss on the prior year’s return may result in a lower tax for that year, often producing a refund – Do the Math

 

When Your Loss Deduction Exceeds Your Income

  • If your loss deduction is more than your income, you may have a Net Operating Loss (NOL)
  • You do not have to be in business to have an NOL from a casualty
  • For more information, refer to Pub 536, Net Operating Losses (NOLs) for Individuals, Estates, and Trusts

 

Net Operating Loss (NOL)– Individuals:

  • Net Operating Losses occur when you have more tax deductions than you have taxable income
  • You may have a NOL if you have a negative number on the line for taxable income before you deduct your personal exemptions- Form 1040, Line 41
  • This can occur in you have a large casualty loss, such as a flood or a fire, and are not reimbursed for the loss from insurance or other possible sources

 

If you have a NOL:

  • Decide whether to carry the NOL back to a past year or to waive the Carry Back period and instead carry the NOL forward to a future year
  • NOL year= This is the year in which the NOL occurred
  • Generally, if you have an NOL for a tax year ending in 2015, you must carry back the entire amount of the NOL to the 2 tax years before the NOL year (the Carry Back period), and
  • Then Carry Forward any remaining NOL for up to 20 years after the NOL year (the Carry Forward period)
  • You can, however, choose not to Carry Back an NOL and only Carry it Forward
  • See IRS Publication 536

 

I realize this is a lot of information to take in at one time. Keep it as a guide, and take one step at a time. The following action steps will help you get started.

 

Action Steps:

  • Inventory your loss by property type- real property (real estate); personal property; automobiles; business property
  • If you own real estate, determine your cost basis
  • If you need to replace IRS information, use their “Get Transcript” tools, for wage/income information and to obtain previous tax returns
  • State tax rules are different; research yours when you can, to see if tax benefits are available there
  • When you can:
  1. Quantify the value of items lost
  2. Quantify the money received to replace part of your loss
  3. Find your initial IRS loss number: Value of items lost – money received = unreimbursed loss
  4. Use the Unreimbursed loss number to see if the IRS rules, included above, can help you recover, at least some, financially
  5. If you have questions, feel free to contact me via e-mail or by phone; if you use e-mail, please do not send attachments or any personal financial information- that information should always be protected. General questions and specific numbers are safe.

 

“In times of turbulence and change, it is more true, than ever, that knowledge is power ” – John F Kennedy

“Tax Filing is mandatory; Tax Planning is optional; Tax Planning & Acting can help you keep more $$ in your pocket rather than Theirs (The IRS)” – Deb Fox

It’s impossible said Pride; It’s risky said experience; It’s pointless said reason; Give it a try whispered heart” – anonymous

 

Thanks for reading,

Deb

 

Deborah Ann Fox, CPA helps Small Business Owners & Individuals build and protect their financial wealth. She can help by being your financial compass while you captain your ship.

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.debfoxfinancial.com

Call 619-549-2717

E-Mail me @ debfoxfinancial@gmail.com 

Twitter: @debfoxfinancial

Facebook: Deborah Ann Fox, CPA