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Small Business Tax Tips Your Should Know

Small Business Tax Tips Your Should Know Small Business Tax Tips Your Should Know

Professional tax preparers for small businesses are already hard at work for the fast-approaching April 15 deadline. S corporations, which almost always follow a calendar tax year, are even shorter on time with a March 15 deadline.

Now that the reporting year has ended, most options to optimize a small business tax return lie in the deductions and credits you choose to claim, or in deciding to file for an extension. The estimated 85 percent of small business owners who file taxes as individuals should also review their returns for any claims that could raise suspicions with the IRS.

Home office deduction changes

Small business tax expert Barbara Weltman says the first thing to do is learn about changes in the tax code that affect entrepreneurs, especially those who work out of their homes.

“The good news is there is a new, simplified home-office deduction, since 52 percent of all small businesses are home-based,” says Weltman, author of J.K. Lasser’s Small Business Taxes.

Up until this year, most entrepreneurs working out of a home office had to make some complicated calculations about the percentage of their home’s square footage that they used for business, the portion of utilities and Internet that went to business use, and so on. Now, a home-based business can deduct $5 per square foot up to a limit of $1,500.

The original calculation method is still available, too. Which one should you take? Weltman advises business owners to compare the flat rate to the deduction they claimed in years past. “If you have a space that’s larger than 300 square feet, you might consider calculating it the old way. That’s the maximum you can have on the simplified method,” she says. The IRS also has an online comparison.

Use your time wisely

If you’ve been keeping good records throughout the year, tax time will be a lot less painful. But it’s also important to give yourself time to go over your paperwork and make sure you have everything you need to complete your return, says Chris Whitcomb, tax counsel for the National Federation of Independent Business.

Give your accountant or tax preparer enough time to complete your return and let you review it, Whitcomb says. Among NFIB’s 350-plus members, Whitcomb says nine out of 10 use an outside tax preparer, tax software, or both.

For sole proprietors, independent contractors, and home-based businesses, doing your own taxes isn’t out of the question. The Small Business Administration notes that tax preparation software is a good option, with one caveat: many free products don’t support business tax filers with necessary forms such as Schedule C. Check to make sure your software has everything you need.

Whitcomb adds that getting organized early also helps you find out if you owe money, and to plan accordingly. “You don’t have to file until April 15. You can plan for that cash flow ahead of time if you have to pay,” he says.

Maximizing deductions

Weltman says tax time is your opportunity to make smart elections. One example is the Section 179 deduction, which allows business owners to write off the entire cost of new equipment in one year rather than taking depreciation over multiple years. Eligible items include machinery, computers, certain software, and furniture. Or, a business can take bonus depreciation, which allows half the cost of qualifying equipment to be deducted this year, with remaining depreciation amortized over the item’s lifetime.

“Depending on your tax picture, you should sit down with your tax advisor to figure out the best depreciation strategy for your business,” Weltman says.

Enjoy these deductions while you can. They’re two of 55 tax breaks that Congress allowed to expire at the end of 2013. Congress could retroactively reinstate them, but for now Weltman says that makes 2014 tax planning difficult. For 2013, a business can write off up to $500,000 under Section 179. That number drops to $25,000 next year, and bonus depreciation is on track to be eliminated altogether.

If you laid the groundwork for a business in 2013, some startup expenses can be deducted, such as money spent on product and market analysis and visiting potential business sites. For more small business expenses and deductions, check out the SBA’s guide.

Finally, some states also have special incentives for businesses that aren’t available from the federal government, Weltman adds. Check the rules and deadlines in your state before you finalize your return.

Audit pitfalls

The SBA advises business owners to avoid these common audit triggers:

Large sum miscellaneous deductions – The IRS takes notice at long lists of itemized deductions that don’t seem to fit your income. Be specific about every deduction and keep the documents to back them up.
Classifying employees as independent contractors–Failing to classify correctly could mean you’ll owe back wages under the Fair Labor Standards Act, and you may pay back taxes and penalties. Visit this guide
Keep business and personal expenses separate – It’s best to maintain a separate bank account or credit card for the business, Weltman advises. But if you didn’t do that in 2013, recordkeeping is the next best defense, especially if you used personal property like a vehicle for your business. Failing to keep business and personal activities separate can mean losing out on business write-offs if your records aren’t clear, she says.

Where Weltman parts ways with the SBA, however, is over the home-office deduction. SBA repeats the long-held belief that having a home office increases your odds of being audited. “Is it a red flag? My opinion is no, because look at how many people work from home today,” Weltman says.

Just make sure you qualify for the deduction, she adds. If your business has a commercial address and you work from home occasionally, that doesn’t pass the test.

And if you’re doing really well, expect extra scrutiny. Those who report $200,000 or more in income automatically fall into a high audit risk category, Weltman says. This year, there is also an additional 0.9 percent Medicare tax on earned income and 3.8 percent tax on net investment income for single filers making $200,000 and married couples filing jointly who make $250,000.

Need more time?

You can file for an extension if April 15 is coming too fast. NFIB’s Whitcomb says it’s better to get your return right than to rush through it just to meet the deadline, especially if you’re missing key supporting documents.

If approved, an extension will give you five to six extra months to prep your return. But remember, you don’t get extra time to pay. Estimate what you owe and send the payment when you file Form 7004 to request the extension. If you’ve already made quarterly payments, furnish that information to the IRS as well. If you owe money but don’t pay, the IRS could reject your application, and interest and penalties will kick in.

Looking ahead

When wrapping up your 2013 return, remember that it’s also time for the first payment of quarterly estimated taxes for 2014, Weltman says. Stay on top of your cash flow projections so you have enough on hand when these payments come due.

Although the expiring tax breaks make for a lot of moving targets, she says it’s best to peg your 2014 tax liability to your 2013 tax obligation. “No matter how much you ultimately owe, at least you won’t have underpayment penalties,” she says.

March 14, 2014 Today's Business, , , , , , , , , , , , , , 0 Read more >

Entrepreneurs: How To Understanding Your Financial Statements

Entrepreneurs: How To Understanding Your Financial Statements
As you consider which legal entity or entities–corporation, limited liability company, or limited partnership–you want to use for your business structure, the decisions you make will depend heavily on your current financial situation, both personal and professional. But do you know how to read a financial statement on your own? Do you know how to read your own personal and business financial statements?

Knowing how to do this is an essential skill not just for entrepreneurs but for everyone. However, for the entrepreneur having this skill can mean the difference between having a thriving business that continues to thrive and winding up in bankruptcy. The annals of the bankruptcy courts are strewn with cases of entrepreneurs who entrusted their accounting to others and, not knowing how to read the financial statements of their own businesses, were surprised when they found that the business was ultimately unsustainable. The purpose of this article is to help prevent this from happening to you–and to arm you with the skills you need to structure your business to your benefit from the outset.

Your Two Major Financial Statements

There are two major financial statements that every entrepreneur should know how to read and (ideally) prepare or have prepared in their financial software (we recommend QuickBooks):

The Income Statement
The Income Statement (also known as the P&L or Profit and Loss Statement) offers a dynamic picture of the ebb and flow of your finances. Briefly, income statement shows first: A. Your various sources of income Then subtracts from that, B. Your expenses To give you the net result: Net Profit or Loss Typically, it is the result shown on this statement that is the basis for your taxation by state and federal authorities at the end of the year. The net income or loss (revenue outgo) is carried over onto your second major financial statement: The Balance Sheet.

The Balance Sheet
Offers you a snapshot of cumulative results of your financial activities. It is made up of two columns:
On the left side you have your Assets

On the right are listed your Liabilities and Owners/Shareholders Equity (or ownership in the business). The two columns must be in balance, which is why this is called a Balance Sheet.

Assets=Liabilities + Equity

It’s really quite logical how the Income Statement and Balance Sheet relate to one another.

If you have to use current or long-term assets to pay ongoing expenses during the current year, at the end of the year, the amount of your assets will be reduced by the amount of net loss. On the right hand side, your Equity has gone down too. If you borrowed, say $10,000 to pay current operating expenses, at year end, your assets remain the same, but your liabilities have increased by $10,000, lowering your net Equity or ownership in the company by that same $10,000.

It doesn’t take a rocket scientist to figure out that if you continue on this path, you will quickly be in a very painful situation, because Liabilities carry their own cost. The cost of borrowing money is Interest, and if you are fortunate enough to borrow at only 10% interest (on unsecured debt) today, a year from now, you will have to pay $11,000 to pay off the original $10,000 debt. This reduces your equity still further–unless you have used the borrowed funds to create more assets that increase in value at the same rate as the interest on your debt or, better yet–at a higher rate.

More to the point for deciding which business entities to use is that you need to work out both your personal financial statements and those of your business(es). If you find, for example, that that you have significant salary or wage income in your personal financial statements that is causing you to pay out high taxes (as reflected in your balance sheet), and you expect that your business will generate some significant losses for the first several years, it would be advantageous to you to use a business entity that is a flow-through entity. Losses incurred by your S-Corporation (or, if you prefer, your Limited Partnership or your Limited Liability Company) will flow onto your personal balance sheet to offset the salary or wage income and thus reduce your tax liability.

Moreover, in general, if you want to draw up a roadmap to getting where you want to go, you need to know your point of departure. Thus, preparing and understanding your personal and business financial statements is an indispensable first step for your business planning.

March 7, 2014 Today's Business, , , , , , , , , , 0 Read more >

Why A LLC Limited Liability Company The Right Formation for Your Business

Why A LLC Limited Liability Company The Right Formation for Your BusinessWhy A LLC Limited Liability Company The Right Formation for Your Business
Should you operate your business as a corporation? Or is there another, simpler alternative. You’ve probably noticed that in the past decade there are more and more businesses with their names followed by the letters “LLC” instead of “Inc.”. “LLC” stands for Limited Liability Company, is the newest type of legal entity that exists in the United States, and for many entrepreneurs it is the ideal marriage between the tax advantages of the limited partnership and the limited liability feature of the corporation. Now available in all 50 states—even to non-U.S. citizens–most likely the LLC should have a key place in your business structure. Why A LLC Limited Liability Company The Right Formation for Your Business

When it comes to legal entities for conducting business, limited liability companies are the newest kid on the block in the United States. The state of Wyoming was the first to pass legislation, in 1977, to establish this new entity. By 1999 all fifty states in the United States had enacted legislation to allow the formation of this exciting new legal entity.

But why is the LLC so attractive, so irresistible to legislators? And why have so many entrepreneurs opted for the LLC instead of a “C” corporation, or even an “S” corporation? And most important, how do you decide if it’s right for you?

Perhaps the most important reason is for the popularity of the LLC that the it satisfies the demands of both accountants and attorneys. Accountants tend to prefer the Limited Partnership (“LP”) because they are concerned about the dangers of “double taxation” if their clients use a corporation: If your corporation pays dividends, the corporation pays taxes on its profits, and its shareholders pay taxes again on those same profits when they are taxed on the dividends they receive. By contrast, attorneys usually prefer the greater asset protection offered by the limited liability that the corporation has to offer to all its owners.

Let’s begin with an understanding of what the limited liability company is. Basically it is a partnership among its owners, who are called “members”. The LLC is like a limited partnership (and an S-corporation), because it is a “pass-through entity”–each partner’s or member’s share of the net gain or loss for the year “flows through” to the individual tax-payer’s 1040 individual tax return. There is no separate tax to which the LLC itself is subject. On the other hand, the LLC is also like a corporation, because unlike the limited partnership–which requires a general partner, who is responsible for all results of all decisions and actions of the partners–all its owners benefit from limited liability. 

People choose to form LLCs basically for the same reasons that they would elect to set up an S-corporation or a limited partnership. The LLC, like the S-corporation, is attractive if you have earned income that puts you in a high tax bracket, and you would like to be able to offset that income with the losses that you can normally expect to incur in your first years in a business. When I formed my first business entity twenty years ago, my husband and I selected the S-corporation. We both had salary income that placed us in a high tax bracket, and we knew that our new consulting business would incur significant capital expenses in the first few years. After all, we would have to purchase new equipment such as a fax machine, a laser printer, personal computers, and the replaceable supplies to operate them. We were also aware that it would take some time to build a clientele, so our income from the business would take a few years to take off. The S-corporation allowed us to carry the losses we incurred onto our individual 1040 tax returns. The losses were deducted from our gross personal salary income, and we paid dramatically lower taxes.

If you can get this advantage from an S-corporation, why would you bother with an LLC? The LLC has a number of advantages over the S-corporation:

1. First, LLC does not have the limitations that the S-corporation has on who can be a member of the LLC. Only individuals, estates, some trusts, and other S-corporations can be members of an S-corporation. Individuals (shareholders) must be either U.S. citizens or residents. By contrast, the LLC is not subject to these limitations. Thus, it is an ideal entity that you can combine with other entities in your business structure. For example, you can have a corporation or other legal entity be a member of an LLC. Why A LLC Limited Liability Company The Right Formation for Your Business

2. The LLC has much greater flexibility for allocation of rights, profits, and assets than the S-corporation. The S-corporation can have only one class of stock: In other words each share of stock has the same rights as every other share. This means that the allocation of profits and assets is extremely rigid. If Parties A and B are equal shareholders in a corporation, and the corporation decides to distribute its profits of $10,000, then A and B must each receive $5,000. This might not necessarily be equitable if one partner was much more active and produced a much greater share of the profits than the other. The LLC allows for A to receive, say, $8,000 if its business activities generated 80% of the profit, leaving B with the remaining 20%, or $2,000. This can be very attractive in a partnership in which there is a significant difference in the amount of capital and ongoing business activity that the partners are contributing to the business.

3. The LLC is not subject to the same corporate formalities that are required of the S or C corporation. While the LLC must still maintain appropriate LLC records and bookkeeping, it is not required to be managed by a board of directors and maintain minutes of regular board of directors meetings.

4. Unlike the S-corporation, liquidation of an LLC is generally not a taxable event. As your personal and business financial situation change over time, you may determine that it is no longer in your interest to maintain a “pass through” entity for your business. Once your business begins to turn a regular profit after the relatively high costs of the first year or two, you may decide that a C-corporation that is taxed at a maximum of 25% (unless it is a personal service corporation) would be more advantageous to you. If you have been operating as an S-corporation and you liquidate it by selling the liquidated assets to the shareholder(s) at their fair market value, the liquidation will be a taxable event. This does not apply to the LLC. This is one of the factors that makes the LLC particularly attractive for holding real estate. Why A LLC Limited Liability Company The Right Formation for Your Business
5. The concept of the charging order makes the LLC especially effective for asset protection. This makes it a particularly attractive entity for holding real estate. The corporation should not be used to hold real estate, because if the corporation is sued, the court might award shares in the corporation in the judgment. Control of the corporation translates into control of the property, and you effectively lose control over your real estate holdings. By contrast, the charging order, used with Limited Liability Companies as with Limited Partnerships, gives the plaintiff only the right to receive income distributions from the interest of the party or parties against whom the suit was brought. The charging order grants no voting rights or management powers. Thus, the existing managers or members could vote simply not to distribute income, thus leaving the plaintiff with no recourse; yet the plaintiff will have to pay taxes on the income allocated to her, even though the funds were not distributed(!). This offers a strong incentive for the plaintiff to negotiate for a settlement.

Clearly, the LLC is a powerful tool for protecting your assets against financial predators. If you use it for real estate holdings, you can maximize this protection by holding each piece of real estate in a separate LLC. Thus, if one LLC comes under attack from financial predators, the operations affecting only a single property will be affected.
Disadvantages of the Limited Liability Company

Needless to say, there are some disadvantages with the LLC–otherwise there would not be remain so many other attractive options for structuring your business. Why might the LLC not be the best option for you?

1. Increased taxes for LLC members in high tax brackets. Once your LLC is making a profit, its income passes through the individual members, who are taxed directly on that income, whether it is actually taken out of the LLC or not. Thus, members who are in a high tax bracket might pay higher taxes than they would if they used a C-corporation, which is subject to lower marginal tax rates. Proper planning of disbursements for expenses and other aspects of the business could overcome this disadvantage.

2. Higher initial filing fees for LLCs in some states. Some states may levy heavier tax obligations on LLCs in their initial years. Our home state of California requires that an LLC pay a minimum $800 tax in its first year, while corporations are exempt in their first year–whether the business has any earnings or not! It can still be worthwhile for you to start an LLC: If you have high start up costs, tax savings in the thousands of dollars will outweigh these higher filing fees.

3. Unlike corporations, LLCs do not have continuity of life, that is they are limited usually to a specific period of time (say, 50 years) depending on the state.
If an LLC member dies, the remaining members may vote to continue the LLC business. LLC interests can be gifted to other family members; and the LLC can have a trust or family limited partnership as a member, thus providing for effective estate planning.

4. The LLC is a relatively untested entity. There is the large body of case law on corporations but on LLCs. We may also expect to see changes in the laws governing LLCs as the implications of this new entity become more apparent to legislators.

Space does not permit coverage of all the advantages and disadvantages of LLCs, but clearly the LLC can be a powerful tool for operating your business, protecting your assets, and planning your estate. It is easy and inexpensive to set up on your own, if you use one or more of the items. Why A LLC Limited Liability Company The Right Formation for Your Business

 

December 17, 2013 Today's Business, , , , , , , , , , , , 0 Read more >

Think Big, Tax Small

What Small Business Can Learn from Big Business Tax Strategies.

by Jen Hickey.

If you’re a small business, chances are you don’t have access to a team of accountants and lawyers to find savings in the tax code. But as it turns out, you don’t need to. Almost every expense is tax deductible if you’re a small business. And recent legislation has dramatically increased the thresholds for certain deductions dramatically for tax years 2010 through 2012.
Pull-Quote.pngTravel and entertainment expenses

Small companies, like their bigger brethren, can write off travel and entertainment expenses. But further savings can be had if a small business adopts an efficient reimbursement method for such costs. Most if not all big businesses have an “accountable plan” for T&E reimbursement. As Barbara Weltman, tax and business attorney and author of J.K. Lasser’s Tax Deductions for Small Business, points out, “these reimbursements are not only deductible, but businesses do not have to include them in their payroll taxes” if they have an IRS compliant accountable plan in place.
Health benefits

Benefit plans are another area often overlooked by small businesses for tax savings. For example, during tax years 2010 through 2013, the Patient Protection and Affordable Care Act provides up to a 35 percent tax credit for businesses that have 25 or fewer full-time-equivalent employees and that cover at least half the cost of their employee’s health insurance. Yet a 2011 Kaiser Family Foundation survey found that only 29 percent of small firms had made an attempt to find out if they were eligible for this credit. And don’t forget that any remaining premium costs (or all of them if your small business doesn’t qualify for the ACA tax credit) can be deducted as a business expense.

Offering a health savings account (HSA) is another way small businesses can achieve tax savings and offset the medical costs of a high-deductible health plan. An HSA is a tax-exempt trust or custodial account set up by an employer to pay or reimburse qualified employee medical expenses; contributions are allowed annually up to set limits for self-only or family coverage. Flexible spending arrangements (FSAs) work similarly by reimbursing employees for eligible medical expenses up to the plan’s limit (capped at $2,500 annually starting in 2013). They are funded through voluntary employee salary reductions. Most notably, contributions to HSAs and FSAs are not subject to payroll taxes, and withdrawals for qualified medical expenses are tax free.
Retirement plan costs

According to the U.S. Department of Labor, 64 percent of all employees in medium- and large-sized firms are covered by an employment-based retirement plan, yet only 34 percent of small firms offer this benefit. Start-up and maintenance costs are often cited as a deterrent.

But small businesses can claim a 50-percent tax credit to help offset the “ordinary and necessary” costs of starting a SEP, SIMPLE, or qualified plan (including a 401k), up to a maximum of $500 per year for each of the first three years of the plan. Even better, this credit dates back to any plans implemented since 2002. As a result, any unclaimed retirement plan startup costs can be retroactively redeemed by amending previous returns going back to that tax year.

“By setting up a small pension fund, you can deduct contributions for employees and, if a sole proprietor, deduct contributions made for yourself,” explains Stephen L. Nelson, a CPA who publishes the website S Corporations Explained and is author of QuickBooks 2011 for Dummies. “Earnings on contributions are tax free until employees receive distributions from the plan. It’s an inexpensive way to encourage savings while lowering your tax rate.”
Debt writeoffs

While the economy may be on a gentle upswing, many small businesses are still recovering from the loss of customers and suppliers swallowed up by the recession. Just like big banks and insurance companies, though, a small business can write off bad debts if it uses the accrual method of accounting. This means the amount must have been previously included in income. And if a bad debt is recovered, accounts can be adjusted for the next tax year.
Company structure

Ultimately, the structure of one’s business will determine how it’s taxed. This begs the question: which structure is the most tax friendly? Well, that depends on the nature of your business and average earnings. “As a sole proprietor or partnership, you’re legally liable for all debts,” Nelson explains. “In addition to income taxes on business income, the owner also pays another tax on business profits through the self-employment tax.”

For some companies, transitioning to an LLC offers the most tax flexibility while limiting personal liability for owners. S corporations do not pay income taxes, as profits/losses are passed through to shareholders who report them on their individual income taxes.

Whether you’re just starting out or considering a change, Weltman recommends meeting with a lawyer to help determine the best structure for your business. And, as Nelson points out, such tax-planning decisions should be made at the start of the year for the next tax season.
Capital investments and capital gains

“If it has a business purpose, it can be deducted,” says Nelson. And more recently, legislation relating to Section 179 deductions, bonus depreciation, and capital gains taxes on certain small business stock sales has become more accommodating. As a result, more and more large corporations are taking advantage of this favorable tax climate to make large capital investments in their production equipment and rolling stock inventory.

“Keep in mind ‘ordinary’ and ‘necessary’ when gathering those receipts,” Nelson reiterates. Internet service, cell phones/smart devices, office furniture and computers, production equipment, software: all these types of investments are deductible and many can now be completely depreciated within their first year of service.

For small companies that generally struggle with limited cash flow, taking full advantage of all these tax strategies can return real dividends in the long run. And it proves that an entrepreneur need not have access to offshore tax shelters or a team of accounting wizards to achieve big tax savings.

March 5, 2012 Today's Business, , , , , , , , , , , 7 Read more >