How business owners may be able to reduce tax by using an S corporation

Do you conduct your business as a sole proprietorship or as a wholly owned limited liability company (LLC)? If so, you’re subject to both income tax and self-employment tax. There may be a way to cut your tax bill by using an S corporation.

Self-employment tax basics

The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for Social Security up to a certain maximum ($137,700 for 2020) and at a 2.9% rate for Medicare. No maximum tax limit applies to the Medicare tax. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases.

Similarly, if you conduct your business as a partnership in which you’re a general partner, in addition to income tax you are subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation, you’ll be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation isn’t subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss and deduction are passed through to the shareholders. However, the income passed through to the shareholder isn’t treated as self-employment income. Thus, by using an S corporation, you may be able to avoid self-employment income tax.

Salary must be reasonable

However, be aware that the IRS requires that the S corporation pay you reasonable compensation for your services to the business. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation doesn’t pay you reasonable compensation for your services, the IRS may treat a portion of the S corporation’s distributions to you as wages and impose Social Security taxes on the amount it considers wages.

There’s no simple formula regarding what is considered reasonable compensation. Presumably, reasonable compensation is the amount that unrelated employers would pay for comparable services under similar circumstances. There are many factors that should be taken into account in making this determination.

Converting from a C to an S corp

There can be complications if you convert a C corporation to an S corporation. A “built-in gains tax” may apply when appreciated assets held by the C corporation at the time of the conversion are subsequently disposed of. However, there may be ways to minimize its impact.

As explained above, an S corporation isn’t normally subject to tax, but when a C corporation converts to S corporation status, the tax law imposes a tax at the highest corporate rate (21%) on the net built-in gains of the corporation. The idea is to prevent the use of an S election to escape tax at the corporate level on the appreciation that occurred while the corporation was a C corporation. This tax is imposed when the built-in gains are recognized (in other words, when the appreciated assets are sold or otherwise disposed of) during the five-year period after the S election takes effect (referred to as the “recognition period”).

Consider all issues

Contact us if you’d like to discuss the factors involved in conducting your business as an S corporation, including the built-in gains tax and how much the business should pay you as compensation.

© 2020


Do you want to go into business for yourself?

Many people who launch small businesses start out as sole proprietors. Here are nine tax rules and considerations involved in operating as that entity.
1. You may qualify for the pass-through deduction. To the extent your business generates qualified business income, you are eligible to claim the 20% pass-through deduction, subject to limitations. The deduction is taken “below the line,” meaning it reduces taxable income, rather than being taken “above the line” against your gross income. However, you can take the deduction even if you don’t itemize deductions and instead claim the standard deduction.
2. Report income and expenses on Schedule C of Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses are deductible against gross income and not as itemized deductions. If you have losses, they will generally be deductible against your other income, subject to special rules related to hobby losses, passive activity losses and losses in activities in which you weren’t “at risk.”
3. Pay self-employment taxes. For 2020, you pay self-employment tax (Social Security and Medicare) at a 15.3% rate on your net earnings from self-employment of up to $137,700, and Medicare tax only at a 2.9% rate on the excess. An additional 0.9% Medicare tax (for a total of 3.8%) is imposed on self-employment income in excess of $250,000 for joint returns; $125,000 for married taxpayers filing separate returns; and $200,000 in all other cases. Self-employment tax is imposed in addition to income tax, but you can deduct half of your self-employment tax as an adjustment to income.
4. Make quarterly estimated tax payments. For 2019, these are due April 15, June 15, September 15 and January 15, 2021.
5. You may be able to deduct home office expenses. If you work from a home office, perform management or administrative tasks there, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of some costs of maintaining your home. And if you have a home office, you may be able to deduct expenses of traveling from there to another work location.
6. You can deduct 100% of your health insurance costs as a business expense. This means your deduction for medical care insurance won’t be subject to the rule that limits medical expense deductions.
7. Keep complete records of your income and expenses. Specifically, you should carefully record your expenses in order to claim all the tax breaks to which you’re entitled. Certain expenses, such as automobile, travel, meals, and office-at-home expenses, require special attention because they’re subject to special recordkeeping rules or deductibility limits.
8. If you hire employees, you need to get a taxpayer identification number and withhold and pay employment taxes.
9. Consider establishing a qualified retirement plan. The advantage is that amounts contributed to the plan are deductible at the time of the contribution and aren’t taken into income until they’re are withdrawn. Because many qualified plans can be complex, you might consider a SEP plan, which requires less paperwork. A SIMPLE plan is also available to sole proprietors that offers tax advantages with fewer restrictions and administrative requirements. If you don’t establish a retirement plan, you may still be able to contribute to an IRA.
Seek assistance
If you want additional information regarding the tax aspects of your new business, or if you have questions about reporting or recordkeeping requirements, please contact us.
© 2020

2020 – 02/04 – There still might be time to cut your tax bill with IRAs

If you’re getting ready to file your 2019 tax return, and your tax bill is higher than you’d like, there may still be an opportunity to lower it. If you qualify, you can make a deductible contribution to a traditional IRA right up until the Wed., April 15, 2020, filing date and benefit from the resulting tax savings on your 2019 return. For 2019 if you’re qualified, you can make a deductible traditional IRA contribution of up to $6,000 ($7,000 if you’re 50 or over). To be qualified, you must meet rules involving your income and whether you’re an active participant in an employer-sponsored retirement plan. If you’d like more information about whether you can contribute to an IRA, contact us.

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Numerous tax limits affecting businesses have increased for 2020

An array of tax-related limits that affect businesses are annually indexed for inflation, and many have increased for 2020. Here are some that may be important to you and your business.

Social Security tax
The amount of employees’ earnings that are subject to Social Security tax is capped for 2020 at $137,700 (up from $132,900 for 2019).
Deductions
Section 179 expensing:
Limit: $1.04 million (up from $1.02 million for 2019)
Phaseout: $2.59 million (up from $2.55 million)
Income-based phase-out for certain limits on the Sec. 199A qualified business income deduction begins at:
Married filing jointly: $326,600 (up from $321,400)
Married filing separately: $163,300 (up from $160,725)
Other filers: $163,300 (up from $160,700)
Retirement plans
Employee contributions to 401(k) plans: $19,500 (up from $19,000)
Catch-up contributions to 401(k) plans: $6,500 (up from $6,000)
Employee contributions to SIMPLEs: $13,500 (up from $13,000)
Catch-up contributions to SIMPLEs: $3,000 (no change)
Combined employer/employee contributions to defined contribution plans (not including catch-ups): $57,000 (up from $56,000)
Maximum compensation used to determine contributions: $285,000 (up from $280,000)
Annual benefit for defined benefit plans: $230,000 (up from $225,000)
Compensation defining a highly compensated employee: $130,000 (up from $125,000)
Compensation defining a “key” employee: $185,000 (up from $180,000)
Other employee benefits
Qualified transportation fringe-benefits employee income exclusion: $270 per month (up from $265)
Health Savings Account contributions:
Individual coverage: $3,550 (up from $3,500)
Family coverage: $7,100 (up from $7,000)
Catch-up contribution: $1,000 (no change)
Flexible Spending Account contributions:
Health care: $2,750 (up from $2,700)
Dependent care: $5,000 (no change)
These are only some of the tax limits that may affect your business and additional rules may apply. If you have questions, please contact us.
© 2019

2020 Q1 tax calendar: Key deadlines for businesses and other employers

Here are some of the key tax-related deadlines affecting businesses and other employers during the first quarter of 2020. Keep in mind that this list isn’t all-inclusive, so there may be additional deadlines that apply to you. Contact us to ensure you’re meeting all applicable deadlines and to learn more about the filing requirements.
January 31
File 2019 Forms W-2, “Wage and Tax Statement,” with the Social Security Administration and provide copies to your employees.
Provide copies of 2019 Forms 1099-MISC, “Miscellaneous Income,” to recipients of income from your business where required.
File 2019 Forms 1099-MISC reporting nonemployee compensation payments in Box 7 with the IRS.
File Form 940, “Employer’s Annual Federal Unemployment (FUTA) Tax Return,” for 2019. If your undeposited tax is $500 or less, you can either pay it with your return or deposit it. If it’s more than $500, you must deposit it. However, if you deposited the tax for the year in full and on time, you have until February 10 to file the return.
File Form 941, “Employer’s Quarterly Federal Tax Return,” to report Medicare, Social Security and income taxes withheld in the fourth quarter of 2019. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until February 10 to file the return. (Employers that have an estimated annual employment tax liability of $1,000 or less may be eligible to file Form 944, “Employer’s Annual Federal Tax Return.”)
File Form 945, “Annual Return of Withheld Federal Income Tax,” for 2019 to report income tax withheld on all nonpayroll items, including backup withholding and withholding on accounts such as pensions, annuities and IRAs. If your tax liability is less than $2,500, you can pay it in full with a timely filed return. If you deposited the tax for the year in full and on time, you have until February 10 to file the return.
February 28
File 2019 Forms 1099-MISC with the IRS if 1) they’re not required to be filed earlier and 2) you’re filing paper copies. (Otherwise, the filing deadline is March 31.)
March 16
If a calendar-year partnership or S corporation, file or extend your 2019 tax return and pay any tax due. If the return isn’t extended, this is also the last day to make 2019 contributions to pension and profit-sharing plans.
© 2019

Help protect your personal information by filing your 2019 tax return early

The IRS announced it is opening the 2019 individual income tax return filing season on January 27. Even if you typically don’t file until much closer to the April 15 deadline (or you file for an extension), consider filing as soon as you can this year. The reason: You can potentially protect yourself from tax identity theft — and you may obtain other benefits, too.
Tax identity theft explained
In a tax identity theft scam, a thief uses another individual’s personal information to file a fraudulent tax return early in the filing season and claim a bogus refund.
The legitimate taxpayer discovers the fraud when he or she files a return and is informed by the IRS that the return has been rejected because one with the same Social Security number has already been filed for the tax year. While the taxpayer should ultimately be able to prove that his or her return is the valid one, tax identity theft can cause major headaches to straighten out and significantly delay a refund.
Filing early may be your best defense: If you file first, it will be the tax return filed by a would-be thief that will be rejected, rather than yours.
Note: You can get your individual tax return prepared by us before January 27 if you have all the required documents. It’s just that processing of the return will begin after IRS systems open on that date.
Your W-2s and 1099s
To file your tax return, you must have received all of your W-2s and 1099s. January 31 is the deadline for employers to issue 2019 Form W-2 to employees and, generally, for businesses to issue Form 1099 to recipients of any 2019 interest, dividend or reportable miscellaneous income payments (including those made to independent contractors).
If you haven’t received a W-2 or 1099 by February 1, first contact the entity that should have issued it. If that doesn’t work, you can contact the IRS for help.
Other advantages of filing early
Besides protecting yourself from tax identity theft, another benefit of early filing is that, if you’re getting a refund, you’ll get it faster. The IRS expects most refunds to be issued within 21 days. The time is typically shorter if you file electronically and receive a refund by direct deposit into a bank account.
Direct deposit also avoids the possibility that a refund check could be lost or stolen or returned to the IRS as undeliverable. And by using direct deposit, you can split your refund into up to three financial accounts, including a bank account or IRA. Part of the refund can also be used to buy up to $5,000 in U.S. Series I Savings Bonds.
What if you owe tax? Filing early may still be beneficial. You won’t need to pay your tax bill until April 15, but you’ll know sooner how much you owe and can plan accordingly.
Be an early-bird filer
If you have questions about tax identity theft or would like help filing your 2019 return early, please contact us. We can help you ensure you file an accurate return that takes advantage of all of the breaks available to you.
© 2020

Wayfair revisited — It’s time to review your sales tax obligations

In its 2018 decision in South Dakota v. Wayfair, the U.S. Supreme Court upheld South Dakota’s “economic nexus” statute, expanding the power of states to collect sales tax from remote sellers. Today, nearly every state with a sales tax has enacted a similar law, so if your company does business across state lines, it’s a good idea to reexamine your sales tax obligations.
What’s nexus?
A state is constitutionally prohibited from taxing business activities unless those activities have a substantial “nexus,” or connection, with the state. Before Wayfair, simply selling to customers in a state wasn’t enough to establish nexus. The business also had to have a physical presence in the state, such as offices, retail stores, manufacturing or distribution facilities, or sales reps.
In Wayfair, the Supreme Court ruled that a business could establish nexus through economic or virtual contacts with a state, even if it didn’t have a physical presence. The Court didn’t create a bright-line test for determining whether contacts are “substantial,” but found that the thresholds established by South Dakota’s law are sufficient: Out-of-state businesses must collect and remit South Dakota sales taxes if, in the current or previous calendar year, they have 1) more than $100,000 in gross sales of products or services delivered into the state, or 2) 200 or more separate transactions for the delivery of goods or services into the state.
Nexus steps
The vast majority of states now have economic nexus laws, although the specifics vary:Many states adopted the same sales and transaction thresholds accepted in Wayfair, but a number of states apply different thresholds. And some chose not to impose transaction thresholds, which many view as unfair to smaller sellers (an example of a threshold might be 200 sales of $5 each would create nexus).
If your business makes online, telephone or mail-order sales in states where it lacks a physical presence, it’s critical to find out whether those states have economic nexus laws and determine whether your activities are sufficient to trigger them. If you have nexus with a state, you’ll need to register with the state and collect state and applicable local taxes on your taxable sales there. Even if some or all of your sales are tax-exempt, you’ll need to secure exemption certifications for each jurisdiction where you do business. Alternatively, you might decide to reduce or eliminate your activities in a state if the benefits don’t justify the compliance costs.
Need help?
Note: If you make sales through a “marketplace facilitator,” such as Amazon or Ebay, be aware that an increasing number of states have passed laws that require such providers to collect taxes on sales they facilitate for vendors using their platforms.
If you need assistance in setting up processes to collect sales tax or you have questions about your responsibilities, contact us.
© 2019

2019 – 11/25 – 2 valuable year-end tax-saving tools for your business


Under current law, there are two valuable depreciation-related tools that may help your business reduce its 2019 tax liability. To benefit from the Sec. 179 and bonus depreciation deductions, you must buy eligible machinery, equipment, furniture or other assets and place them into service by the end of the tax year. In other words, you can claim a full deduction for 2019 (up to certain limits) even if you acquire assets and place them in service during the last days of the year. It’s important to note that these deductions may also be used for business vehicles. But, depending on the type of vehicle, additional limits may apply. Please contact us to learn more.

Holiday parties and gifts can help show your appreciation and provide tax breaks

With Thanksgiving behind us, the holiday season is in full swing. At this time of year, your business may want to show its gratitude to employees and customers by giving them gifts or hosting holiday parties. It’s a good idea to understand the tax rules associated with these expenses. Are they tax deductible by your business and is the value taxable to the recipients?

Customer and client gifts

If you make gifts to customers and clients, the gifts are deductible up to $25 per recipient per year. For purposes of the $25 limit, you don’t need to include “incidental” costs that don’t substantially add to the gift’s value, such as engraving, gift wrapping, packaging or shipping. Also excluded from the $25 limit is branded marketing collateral — such as small items imprinted with your company’s name and logo — provided they’re widely distributed and cost less than $4.

The $25 limit is for gifts to individuals. There’s no set limit on gifts to a company (for example, a gift basket for all team members of a customer to share) as long as they’re “reasonable.”

Employee gifts

In general, anything of value that you transfer to an employee is included in his or her taxable income (and, therefore, subject to income and payroll taxes) and deductible by your business. But there’s an exception for noncash gifts that constitute a “de minimis” fringe benefit.

These are items small in value and given infrequently that are administratively impracticable to account for. Common examples include holiday turkeys or hams, gift baskets, occasional sports or theater tickets (but not season tickets), and other low-cost merchandise.

De minimis fringe benefits aren’t included in your employee’s taxable income yet they’re still deductible by your business. Unlike gifts to customers, there’s no specific dollar threshold for de minimis gifts. However, many businesses use an informal cutoff of $75.

Important: Cash gifts — as well as cash equivalents, such as gift cards — are included in an employee’s income and subject to payroll tax withholding regardless of how small and infrequent.

Throwing a holiday party

Under the Tax Cuts and Jobs Act, certain deductions for business-related meals were reduced and the deduction for business entertainment was eliminated. However, there’s an exception for certain recreational activities, including holiday parties.

Holiday parties are fully deductible (and excludible from recipients’ income) so long as they’re primarily for the benefit of non-highly-compensated employees and their families. If customers, and others also attend, holiday parties may be partially deductible.

Spread good cheer

Contact us if you have questions about giving holiday gifts to employees or customers or throwing a holiday party. We can explain the tax rules.

© 2019


You may have to pay tax on Social Security benefits

During your working days, you pay Social Security tax in the form of withholding from your salary or self-employment tax. And when you start receiving Social Security benefits, you may be surprised to learn that some of the payments may be taxed.

If you’re getting close to retirement age, you may be wondering if your benefits are going to be taxed. And if so, how much will you have to pay? The answer depends on your other income. If you are taxed, between 50% and 85% of your payments will be hit with federal income tax. (There could also be state tax.)

Important: This doesn’t mean you pay 50% to 85% of your benefits back to the government in taxes. It means that you have to include 50% to 85% of them in your income subject to your regular tax rates.

Calculate provisional income

To determine how much of your benefits are taxed, you must calculate your provisional income. It starts with your adjusted gross income on your tax return. Then, you add certain amounts (for example, tax-exempt interest from municipal bonds). Add to that the income of your spouse, if you file jointly. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your provisional income. Now apply the following rules:

  • If you file a joint tax return and your provisional income, plus half your benefits, isn’t above $32,000 ($25,000 for single taxpayers), none of your Social Security benefits are taxed.
  • If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, you must report up to 50% of your Social Security benefits as income. For single taxpayers, if your provisional income is between $25,001 and $34,000, you must report up to 50% of your Social Security benefits as income.
  • If your provisional income is more than $44,000, and you file jointly, you must report up to 85% of your Social Security benefits as income on Form 1040. For single taxpayers, if your provisional income is more than $34,000, the general rule is that you must report up to 85% of your Social Security benefits as income.

Caution: If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a significant tax cost. You’ll have to pay tax on the additional income, you’ll also have to pay tax on (or on more of) your Social Security benefits, and you may get pushed into a higher tax bracket.

For example, this might happen if you receive a large retirement plan distribution during the year or you receive large capital gains. With careful planning, you might be able to avoid this tax result.

Avoid a large tax bill

If you know your Social Security benefits will be taxed, you may want to voluntarily arrange to have tax withheld from the payments by filing a Form W-4V with the IRS. Otherwise, you may have to make estimated tax payments.

Contact us to help you with the exact calculations on whether your Social Security will be taxed. We can also help you with tax planning to keep your taxes as low as possible during retirement.

© 2019