Tag Archives: small business

Employee Owners and Accountable Plans

Posted in Accounting, business entity, IRS, Payroll, Small Business, Small Business Finance, Tax, Tax Planning by

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A famous quote by Robert A. Heinlein is “When one teaches, two 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 gets – all 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.

Alphabet – Tax Terms & Tips

Posted in Accounting, Bookkeeping, ENTREPRENEUR, Independent Contractor, Personal Finance, Small Business, Small Business Finance, Tax, Tax Planning, taxes by

 

“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 a 1099–MISC 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”?

Posted in Accounting, Bookkeeping, Budgets, business entity, ENTREPRENEUR, Financial Planning, IRS, legal entity, Small Business, State Statue, Strategy, Tax, Tax Planning, taxes by

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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.

Does the IRS think you have a Business?

Posted in Accounting, Bookkeeping, Budgets, ENTREPRENEUR, Financial Planning, Home Business, IRS, MONEY, Small Business, Strategy, Tax Filing, Tax Planning by

2013 Tax

Many taxpayers started a business and thought, or were told, “Don’t worry about the expense, it’s a write off on your tax return”.

The truth is that this may or may not be true.

Tax is not a cookie-cutter industry and as you can probably guess, the IRS did not make a “One Size Fits All” tax rule for write-offs.

If your intent is to enjoy your hobby and perhaps make some incidental income, this blog may not be of interest to you.

If your intent is to make money through a legitimate business, as defined by the IRS – this is for you

  • My purpose is to provide you “heads up” and “eyes open” to help ensure your business and financial success
  • This blog is provided to help educate you on how to organize, manage and conduct your business to improve your chances with the IRS in the event that your “activity” is audited ***

 

IRS Hobby VS Business Rules:

  • An “Activity” is either a hobby or a business
  • The IRS uses facts to decide if an activity is a (hobby) or a business
  • Neither the Code nor the Regulations provide an absolute definition
  • It is difficult for a taxpayer to win a hobby-loss case at the Tax Court level
  • If your tax return pays tax as a business and the IRS finds that it is a hobby, your tax return can be corrected and your tax liability could go up; i.e. you might owe the IRS money ***
  • The financial adjustment may be significant. In addition to the loss of the deductions, you, may face a §6662 understatement penalty for the tax years in question ***

 

Hobby Rules:

  • An activity is presumed to be a Hobby if a profit is not earned in at least 3 taxable years of a consecutive 5-year period
  • A taxpayer can overcome the presumption if he/she can show the activity was operated with a For-Profit motive
  • Under IRC §183, a taxpayer’s deduction for Hobby losses is limited to the income produced
  • You must itemize deductions to claim hobby expenses on your tax return
  • Hobby expenses, along with other miscellaneous expenses you itemize on Schedule A, must come to more than 2% of your adjusted gross income before you can deduct them
  • Hobby Expenses can bring your Hobby Gross Income, to zero
  • Income is reported on your IRS Form 1040, Line 21, Other Income
  • I understand that this can be confusing, so I will rephrase differently, to help bring clarity:
  • Hobby Income needs to be reported
  • Hobby Expense deductions have 3 limitations:
  1. Total Itemized Deductions have to be greater than your Standard Deduction
  2. Hobby expense deductions are limited to the hobby income produced, and then
  3. Then those expenses must be reduced by 2% of your Adjusted Gross Income (AGI)

 

Business Rules:

  • A Business has a For-Profit motive
  • A simple, general rule is that if the business makes a profit in 3 of 5 years there will be a presumption of profit
  • IRC § 183(d) is a safe harbor for the taxpayer
  • If the business is For-Profit, no limit on deductions is imposed and the taxpayer may be able to use losses to offset (reduce) other taxable income
  • If an activity has not produced profits in three of the past five years, the taxpayer may still argue that the business has a profit motive by relying on Reg. §1.183-2, which provides for a nine-factor test
  • More weight is given by the courts to the objective facts (rather than to the taxpayer’s statement intent) Dreicer v. Comr., 78 T.C. 642 (1982)
  • Judicial decisions suggest that no one factor is controlling
  • Court decisions often seem to consistently rely on the first factor as the most important

 

The prevailing regulations list nine critical factors for determining whether an activity constitutes a Hobby or a Business. They are:

  1. The manner in which the taxpayer carries on the activity
  2. The expertise of the taxpayer or his or her advisers
  3. The time and effort expended by the taxpayer in carrying on the activity
  4. The expectation that assets used in the activity may appreciate in value
  5. The success of the taxpayer in carrying on other similar or dissimilar activities
  6. The taxpayer’s history of income or losses with respect to the activity
  7. The amount of occasional profits, if any, which are earned by the taxpayer
  8. The financial status of the taxpayer
  9. Any elements of personal pleasure or recreation

 

Business Tax Reporting:

  • A Sole Proprietor or Qualified Joint Venture will file a federal return on Form 1040 and Schedule C- Profit or Loss from Business
  • If you have another Schedule C business activity; a separate Schedule C is required for each business; the same is true for your business records
  • Check to see what tax reporting is required by your state tax board and local municipality
  • The IRS expects you to pay tax as the money is earned
  • If you operate on a calendar year, due dates are 4/15, 6/15, 9/15, and 1/15 for the previous year
  • Quarterly estimated tax payments should be paid if you expect to owe more than $1,000 in federal taxes on an annual basis
  • Use 1040ES for Individual Estimated Payments
  • Reconcile payments on your annual Year End tax return
  • Self-Employment tax of 15.30% is required on all Annual Net Earnings of more than $400

 

Building the Foundation for a For-Profit Business Intent

Tips for Success:

  • Conduct your business, like a business, consistently
  • Consistency includes Quarterly tax reporting and payments – as required
  • Quarterly reporting requires that your accounting records be current – so you know if you have a profit or a loss
  • Taxpayers bear the burden of proving that they engaged in the activity with an actual and honest objective of realizing a profit
  • Keep detailed financial records
  • Credit Card and Bank statements and cancelled checks are not enough- the IRS needs to see the detail of what you bought
  • Receipts are your Audit Protection – the IRS has Strict Substantiation Requirements
  • The Cohen Rule,” states that you can use “other credible evidence,” or rely on IRS Publication 463 which states that you don’t need to keep receipts for expenses under $75 – it is safer to save all receipts and to follow a consistent business practice
  • Don’t use Cash: it is hard to track, easy to spend and nearly impossible to reconcile with receipts
  • Establish separate checking and credit accounts for your business – don’t co-mingle business & personal funds
  • Keep a Time/Activity Log- Outlook or Google calendar may be requested during an audit
  • If you have had business losses and made changes in the attempt to improve profitability, keep a list of changes made and the date the change was made
  • Establish a level of expertise by attending seminars, networking, and joining professional organizations related to the activity
  • Anticipate that you could be audited ***
  • Pursue your passion, enjoy the journey, and ask questions as you learn along the way

 

If you want to learn more about IRS tax rules, contact for me for a $75.00 Special: includes a 45 minute Q&A phone session plus a free “cheat sheet” for your personal use. The “cheat sheet” includes accounting/tax tips about what is a deductible expense, etc. Offer is valid until 9/5/16.

 

“Success is nothing more than a few simple disciplines practiced every day” – Jim Rohn

“To open a shop is easy; to keep it open is an art” –Chinese Proverb

 

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

10 Quotes to “Invest in Your Success”

Posted in ENTREPRENEUR, Small Business, Strategy by

In honor of ‘Small Business Week 2016”, I offer you 10 quotes to help you ‘Invest in your Success’, the theme for this years celebration.

Dreams, put into action, are the initial seeds we sow before we might become an Entrepreneur or Small Business Owner

  • “We all have dreams. But in order to make dreams come into reality, it takes an awful lot of determination, dedication, self-discipline, and effort”- Jesse Owens

Education

  • The road to success is always under construction” – Paul Harvey

Experience

  • “In theory, there is no difference between theory and practice. In practice, there is” – Yogi Berra

Self-Development Growth

  • It may be hard for an egg to turn into a bird: it would be a jolly sight harder for it to learn to fly while remaining an egg.”  – C. S. Lewis

Process – Think, Plan, Execute, Monitor, Measure – Repeat

  • “Change does not roll in on the wheels of inevitability, but comes through continuous struggle. “ – Martin Luther King, Jr.

Investments – Time & Money

  • “Price is what you pay; value is what you get” – Warren Buffet

Measure – Return on Investment (ROI)

  • “The most dangerous kind of waste is the waste we do not recognize” – Shigeo Shingo

Business Efficiencies

  • “I cannot say whether things will get better if we change; what I can say is they must change if they are to get better.”  – Georg C. Lichtenberg

Improvement – Mentor- an easier way to learn and increase efficiencies – Avoid learning the “hard way”

  • That’s the result of Leadership. To make sure that which shouldn’t happen, doesn’t happen” – Tony Blair 

Success- is not a seamless journey. Probably boring if it was. We learn as we grow.

  • I don’t want to get to the end of my life and find that I lived just the length of it. I want to have lived the width of it as well.” Diane Ackerman 

The10 most powerful 2 letter words; If It Is To Be, It Is Up To Me

Thanks for reading!

Deborah Ann Fox, CPA is working to make a difference in peoples lives and wallets, by helping them build and protect their financial health. Her mission is to be an affordable & accessible resource to help answer money questions for individuals and small business. She can help by being your compass while you captain your ship.

Debbie offers free 30 minute no obligation consultations and is available for appointments – including remote. More information is available at http://www.debfoxfinancial.com. Questions or comments can be sent to debfoxfinancial@gmail.com 

 

 

SBW2015: Showing Gratitude for all Small Business Owners

Posted in Budgets, Cash Flow Management, Financial Planning, MONEY, Small Business by

Risk

America is celebrating National Small Business Week all over the country & special events will be held May 4 – May 8, 2015 in cities across the United States & via the web. It is a time that we as consumers can show our appreciation for local business by shopping locally & promoting them by sharing their information with others.

As a small business owner myself, I also thought it would be fun to share a few financial tips that may be helpful to other small business owners. It is another small way to say thank you & show support to my community.

Take Time to Work On Your Business & Not Just In It:
• Financial Statements & Tax Returns both tell a financial story & can be used as a road map or a compass to help guide profitability
• On at least a quarterly basis, Compare your Budgeted/Forecasted Amounts to Actual Results to identity differences (variance)
• Try to determine why there was a difference, if any, & adjust as necessary
• Also compare Year to Year Actual Results – where is your value being created & lost?

Watch The Bottom Line by Protecting your Assets & Managing your Risk:
• On 10/1/15, the financial responsibility (liability) starts to shift for fraudulent transactions to U.S. merchants if they have not upgraded their payment systems to accept EMV Chip Payment Cards. This is true if the card issuing company has added the chip to their card & you have not upgraded your POS system. Rules vary by issuing card companies & products sold. More information can be found from http://www.darkreading.com at : http://t.co/1OqiwTLY0P
• Know your Net Worth & make a conscious decision about how much of it you want to protect by buying insurance & how much you want to “self-insure”

Try Not to Leave Money on the Table:
• Avoid financial pitfalls, fines, & penalties by knowing & applying FLSA laws correctly including classifying Exempt, Non-Exempt, & Independent Contractors & treat them & pay them correctly
• Use the tax laws to strategically plan your business operations to minimize tax expense & keep more money “in your pocket”

Deborah Ann Fox, CPA helps individuals & small business owners build & protect their financial wealth. She is available for in-person, or remote appointments. See http://www.debfoxfinancial.com for more information.

Your Personal Income – Learn, Grow, Achieve

Posted in Budgets, ENTREPRENEUR, Financial Planning, MONEY, Personal Finance by

 It is a new year and many of us have renewed energy, vision, & goals we want to accomplish- make more money, get out of debt, buy a home, prepare to retire, have more time with our family.

To help, I thought I would write a short series of articles that might be resourceful in helping you reach some of your goals.

To begin, I thought we would start at “the top” of most people’s list and take a look at money; i.e. our personal income.

In future blogs, I will provide info on how we spend, save, & can protect the money we earn.

First, lets look at some words that describe our Personal Income:

1. Learn:

Disposable Income = Income – taxes

This term is kind of a misnomer. Disposable sounds like we don’t really need the money when in reality we do, to pay our bills.

Discretionary Income = Income – taxes – all monthly payments

This is what companies use to decide to whom to market their product. The more discretionary income we have, the higher priced items are “presented” to us. They are a lure. It is always our choice. Do we save, invest, build for tomorrow or enjoy today?

Our discretionary income varies by which stage in life we are: student, raising children, retired.

IRS Income Terms:

The IRS uses the term “Ordinary Income” which basically includes all income except for income except income from Long Term Capital Gains.

Ordinary Income includes:

Earned Income: Money earned in exchange for services

  • Work for someone & receive payment for services
  • Self-Employment

Not “Earned” Income:

  • Interest
  • Dividends
  • Retirement Income
  • Social Security Payments
  • Unemployment
  • Alimony
  • Child Support

Portfolio Income

  • Interest
  • Dividends
  • Annuities
  • Royalties not derived in the ordinary course of your trade or business
  • Gains & Losses – not derived in the ordinary course of trade or business

There are other income terms that we hear others say: Recurring income such as the commission earned by insurance agents and web hosts as they almost automatically renew us each year. Residual Income  is royalty income earned by the owner of intellectual property – books, lyrics, music, patents.

  1. Grow:

This “Income definition review” is not about definitions. It is to help you think about:

  • What kind of income am I making now and how much does it “cost” me?
  • Is the income I earn from a variety of sources or am I dependent on a single source?
  • What do I want to build for tomorrow?
  1. Achieve:

Remember the slogan, “Work Smarter, not Harder?

“Passive Income” is based on “leverage”; we can increase our time productivity by creating assets that work for us and can pay us while we are busy doing other things we enjoy.

 Designing your life to include some passive income could allow you to do more things with your time. It can create a sort of financial “safety net” if you become sick, injured, or have a family emergency that prevents you from working at a typical job. For some, it allows them to have more freedom of choice in their life about where, when, and how they “work” to earn an “income”.

Many of us learned during the recent recession that we should not rely on a single source of income to keep us financially safe. We need to “spread our risk” and not have all (or too many) “eggs in one basket”.

Some people try to create multiple income streams because it provides more financial security and reduces their “dependency” on a single source of income.

Here are some ideas to help get you started:

  • Think about getting involved in the #sharing economy – rent out something you are not using (house, car, bike)
  • Write a series of e-books and sell on Kindle (http://www.stevescottsite.com)
  • Create an App
  • Sell memberships, advertisements, or affiliate links from your blog or website
  • Buy rental property
  • Set up a Self-Directed IRA & invest in mortgage notes, etc. (see my previous blog)
  • Be a bank- Peer to Peer Lending
  • Turn your passion into profit – start a small business or trade services

As you think about reaching your money goals for this year, you could earn more money, spend less, or do both. If you decide to earn more, what can you do to leverage your time, increase your productivity and your net worth?

“A wise person should have money in their head, but not in their heart” – Jonathan Swift

Deborah Fox, CPA is working to make a difference in peoples hearts, lives, and wallets by helping others protect their financial health. She is available for side by side, remote, or mobile appointments. More information is available at www.debfoxfinancial.com. Questions or comments can be sent to debfoxfinancial@gmail.com. Thanks for reading.

What you don’t know can hurt you

Posted in Cash Flow Management, Financial Planning, Financial Wellness, Personal Finance, Risk Management, Small Business, Small Business Finance by

RiskIgnorance may be bliss, but what you don’t know, can also hurt you.

You work hard for your money. You want to enjoy it, stretch it, and protect it.  Personal Risk Management is a way to protect your money. It is a systematic process of evaluating the chance of loss and then taking steps to combat the potential risk by practicing risk avoidance, using contractual indemnification, or by purchasing insurance.

One example of risk avoidance is if a sole-proprietor choses to incorporate and thus limits their personal liability exposure.

Contractual indemnification is a common clause in many contracts. Black’s Law Dictionary defines indemnity as a ““a duty to make good any loss, damage, or liability incurred by another.” Indemnity has a general meaning of holding one harmless; that is to say, that one party holds the other harmless for some loss or damage. Indemnification protects you against personal liability.

Insurance helps to stop an insured “loss” from being a financially life-changing event.

Most people probably find insurance boring and reading insurance contracts even more so. As a CPA, with the Associate in Risk Management (ARM) designation, I enjoy looking for the “devil in the details”. It is one way I provide value to others.

The goal of this blog is to plant some seeds of thought, initiate action, and provide you some “sleep insurance” because you took the time to evaluate, know, and feel comfortable with your financial position.  Factors to consider include:

Limits and Exposure:

  • Know what you have to protect:  What is your net worth; i.e. how much could you lose?
  • What type of losses are you covered for?
  • What percentage of your net-worth is protected by insurance and what amount is left “self-insured” in the event of a loss?

Property:

  • Do you know that if you do not buy the correct property insurance limit that you could be held financially responsible, for a portion of the loss? This is called the co-insurance requirement; read your policy
  • What does your insurance cover you for?
  • Do you have a property “named peril” or an “all-risk” policy? A Named Peril policy only provides coverage for the peril specifically named. An All Risk policy provides coverage for all losses not specifically excluded from coverage
  • If you do not have an All Risk policy, your fire policy might include “extended coverage”. Rev Shaw is an easy acronym to see what might be covered other than loss caused by a fire. R=Riot, E=explosion, V=Vehicle; S=smoke; H=hail; A=aircraft; W=Wind

Liability:

  • How do you determine the policy limit that you buy on your auto, homeowners, or Business Owners Policy? Do you buy the minimum limit or do you also have an Umbrella policy that responds in the event that a loss exceeds your primary limit?
  • In a Money magazine 2/5/14 article, Ed Charlebois of Travelers Insurance said “More than 80% of umbrella losses are auto-related,” If you remodel, does your general contractor make sure that the subcontractors are covered for worker’s compensation and general liability? Do you own a swimming pool, hot tub, or boat that increases your risk/exposure for a loss?
  • If you are a business owner, do your contracts require you to name others as an Additional Insured on your policy? Do you know that this means you are sharing your policy limit (s) with others? Is your defense coverage included in your policy limit?

Your insurance agent can help you review the type of coverage you buy. From a risk management perspective, insurance agents/brokers generally will not tell you how much insurance to buy; this increases their liability.  Likewise, I would not suggest limits either. I could, however, help you determine your exposed net worth and help you review how well you are covered from a property/casualty (liability) perspective.

Warren Buffet said, “Risk comes from not knowing what you are doing”.  Take the time to know and sleep well tonight.

Deb Fox is working to “make a difference in peoples lives, hearts, and wallets”. Although she earned her CPA designation in 1997, she is not currently practicing as a CPA. She does use her knowledge to help others protect their financial health and is available for side –by- side, remote, or mobile appointments.

Website: www.debfoxfinancial.com

E-mail: debfoxfinancial@gmail.com

Twitter: @debfoxfinancial

Have you reviewed your legal business structure for tax savings and/or liability?

Posted in Budgets, Cash Flow Management, Financial Planning, Financial Wellness, IRS, Risk Management, Small Business, Small Business Finance, Tax Filing, Tax Planning by

Tax Time is a great time to review your business financial life and determine if there are changes you can make to help you keep more of the money your earn in your pocket. One way to do this is to see if your legal business structure provides you the best opportunity for tax savings and/ or more limited liability.

In the U.S., there are four major legal choices to chose from when deciding how to operate your business: sole proprietorship, partnership, corporation, and the limited liability company. There are also variations within these categories, such as the S-corporation.

Making this decision is complicated and both an attorney and an accountant should be consulted to provide information to help you decide which form may be best for your business. Factors to consider include:

  • Legal Liability
  • Tax implications
  • Cost of formation and record keeping
  • Flexibility
  • Future needs

As someone with both an accounting and risk management background, I look at choices from both perspectives. The number side of me wants to find out if there is a way to save money. The risk management part of me wants to make sure we are protecting the money we have. The following business entity review focuses upon these two aspects.

Liability can arise from negligence, statutory law, and assumption by contract. The risk of potential liability varies by business entity form.

Sole Proprietor: Flying Solo

  • Taxpayer is the owner; the business is not separate
  • Unlimited exposure to liability
  • All debts or claims against the business can be filed against the owners’ personal property
  • If the owner is sued, insurance is the only form of protection
  • The business itself is not taxed separately; The IRS calls this “pass-through” taxation, because the business Profit and Loss passes through the business to be taxed on your personal tax return
  • Tax is based on your personal income level and is taxed at graduated rates
  • File your personal income tax on Federal Form 1040 and all business information on Schedule C or Schedule F, Profit or Loss from the business
  • Sole Proprietors must pay both the employer and the employee side of Social Security and Medicare taxes; this is called Self-Employment tax
  • Self-Employment tax is required if your annual net-earnings is more than $400
  • The self-employment tax rate for 2014 is 15.3% of the first $117,000 of income and 2.9% of everything above that amount
  • Self-Employment taxes are reported on Federal Form Schedule SE
  • Sole Proprietors can deduct ½ of this cost on 1040-Line 27, the deductible part of self-employment tax 

Partnership: Two or More

  • General Partnerships: Partners are exposed to unlimited liability for business expenses
  • Limited Partnerships: General Partner is personally liable; Limited Partners have limited liability unless they are participating in management
  • Depending on the form, Partners may lose their investment and/or personal assets as well
  • Partners are not employees and should not be issued a W-2
  • Partnerships file an annual information return on Federal Form 1065; Schedule K1 form is used for the individual member’s profit and loss allocations
  • Individual Partners file their personal tax information on Federal Form 1040 and Schedule E, Supplemental Income and Loss
  • Taxable at the personal income level and at the graduated rates
  • File Self-Employment tax on Schedule SE; see Sole Proprietor for additional information

C-Corporation: Double-Taxation applies

  • Separate legal entity that exists, separately and is distinct from its owners
  • Owners’ personal assets are protected from claims against the corporation
  • Generally, the owners of a corporation cannot lose any more than they have invested in the corporation
  • The corporation is taxed and can be held legally liable for its actions
  • 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
  • Owners do not pay tax on corporate earnings unless they receive money as compensation for services or as dividends
  • The corporation pays taxes on the annual net earnings and files Federal Form 1120
  • Corporate owners, who want to leave some profit in the business, may benefit from lower corporate rates
  • For example, 2013 corporate tax rates are 15% for taxable income below $50K, plus 25% for taxable income between $50K-$75K; perhaps, lower than individual rates
  • Corporate taxation is more complicated than the pass-through taxation
  • Self-Employment tax does not apply; FICA payroll taxes are shared 50/50 between the corporation and the employee

Limited Liability Company (LLC) – Single Member

  • An LLC is an entity created by state statute
  • LLCs are state entities, so the level of legal protection given to a company’s owners depends upon the rules of the state in which the LLC was formed
  • Tax reporting depends on the status of the LLC
  • Depending on elections made by the LLC and the number of members, the IRS will treat an LLC either as a corporation, partnership, or as part of the owner’s tax return; i.e. a disregarded entity
  • An LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes unless it files Form 8832 and elects to be treated as a corporation
  • If a single-member LLC does not elect to be treated as a corporation, the LLC is a “disregarded entity,” and the LLC’s activities should be reflected on its owner’s federal tax return on Federal Form 1040 and Schedule C, Schedule E, or Schedule F
  • An individual owner of a single-member LLC that operates a trade or business is subject to the tax on net earnings from self employment in the same manner as a sole proprietorship
  • 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 corporation
  • All income, gain, loss, and deduction flow through to members unless the LLC is taxed as C-Corp
  • No double taxation unless the LLC choses to file as a corporation
  • Taxable at the personal income level and at the graduated rates
  • Self-Employment Tax applies except if the LLC operates as C-Corp
  • File Self-Employment tax on Schedule SE; see Sole Proprietor for additional information

Subchapter S-Corporation (S-Corp): Double Taxation does not apply

  • Separate legal entity
  • Limited liability for shareholders, officers, and directors
  • Generally, a corporation’s shareholders are not personally liable for the corporations debts just because they have ownership in the business; the same is true for the members of an LLC
  • S corporations are corporations that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes
  • Generally, the S-Corp does not pay Income Tax at the Corporate level; they can be responsible for tax on certain built-in gains and passive income at the entity level
  • Self-Employment tax does not apply
  • Many small business owners use S-Corps because they can save a business owner Social Security and Medicare taxes
  • Owners receive a salary and normal payroll taxes apply
  • As an owner-employee, the corporation pays ½ of the payroll tax which can be a substantial tax savings to the owner-employee
  • An S corporation must pay reasonable employee compensation to a shareholder-employee in return for the services the employee provides before a distribution
  • File S-Corp informational return on Federal Form 1120-S
  • Income, gain, loss, and deduction is passed through to share holders
  • Shareholder-employees will receive two tax documents from the S-Corporation: a W-2 wage statement and a Schedule K-1 statement
  • Shareholders report the flow-through of income and losses on their personal tax returns; taxed are based upon the individual income tax rates
  • Double-Taxation does not apply
  • Shareholder-employees are taxed on their salary income and on any profits distributed by the S-Corporation
  • Profit distribution is not subject to FICA payroll taxes; salaries paid must be reasonable for services provided
  • Shareholder-Employees file Federal Form 1040 and Schedule E – Supplemental Income and Loss
  • Under California law, the S corporation is subject to a 1.5 percent tax on its net income
  • See if special tax rules apply in your state

Understandably, reading about tax implications and legal liability might seem a bit boring. Most would agree. Think about it this way:

  • Money saved is money you do not need to earn
  • Knowing you are protected is a good form of “sleep insurance”

Chinese Proverb: To open a shop is easy; to keep it open is an art.

Deb Fox can be reached via twitter @ debfoxfinancial or via e-mail @ debfoxfinancial@gmail.com.

http://www.debfoxfinancial.com/