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    Must Know Tax Tips for Small Businesses
    Must Know Tax Tips for Small Businesses
    Must Know Tax Tips for Small Businesses
    Ebook159 pages2 hours

    Must Know Tax Tips for Small Businesses

    By Frank Gutta

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    About this ebook

    This contains financial and tax topics from starting a business to taking advantage of the code to minimize your tax burden. It is also a resource for quick and straightforward tax answers.
    LanguageEnglish
    PublisherAuthorHouse
    Release dateDec 1, 2010
    ISBN9781452095721
    Must Know Tax Tips for Small Businesses
    Author

    Frank Gutta

    CPA in public practice for over 25 years, specializing in small business Accounting, Tax & Financial Planning.

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      Book preview

      Must Know Tax Tips for Small Businesses - Frank Gutta

      CHAPTER I

      BUSINESS ORGANIZATIONS

      IF YOU HAVE A GREAT idea for a business and are eager to begin, planning properly is very important. One of the major choices is how to organize your business or in other terms how will you elect to run your business? The form of organization your business takes controls how income and deductions are reported to the government on a tax return, how income is shared and so forth. There are many influences that govern what election or type of company you select, whether a sole proprietorship, partnership, limited liability company, subchapter-S corporation or subchapter-C corporation. Each is important to understand in order to make the right selection based on individual circumstances.

      Sole Proprietorships

      A business without partners is considered a sole proprietorship. For tax purposes, proprietor means any unincorporated business owned entirely by one person. You may have to register your business with your city, town, or county government stating that you are doing business as the XYZ Company or some other name. This is sometimes referred to as a DBA (Doing business as).

      Some individuals who consider themselves to be in business for themselves—reporting their income and expenses as sole proprietors—may still be treated as employees for purposes of employment taxes. These individuals include:

      • Corporate officers

      • Agent-drivers or commission-drivers engaged in the distribution of meat products, bakery products, produce, beverages other than milk, laundry or dry-cleaning services

      • Full-time life insurance salespersons

      • Homework’s who personally perform services according to specifications provided by the service recipient

      • Traveling or city salespersons engaged on a full-time basis in the solicitation of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar businesses.

      Day traders in securities may be viewed as being engaged in a trade or business in securities if they seek profit from daily market movements in the prices of securities (rather than from dividends, interest, and long-term appreciation) and these activities are substantial, continuous, and regular. Reporting expenses are done on a Schedule-C and investment interest is not subject to the net investment income limitation that otherwise applies to individuals. Income is not reported on a Schedule-C but on a Schedule-D for gains and losses. Gains and losses from trading activities are not subject to self-employment tax.

      Husband and wives who file jointly and conduct a joint venture can opt not to be treated as a partnership, which requires filing a partnership return (Form 1065) and reporting two Schedule K-1s. Instead, they each report their share of income on Schedule C of Form 1040. To qualify each must materially participate in the business and there can be no other co-owners.

      A limited liability company (LLC) can be formed as a single owner in every state. From a legal standpoint, an LLC gives the owner protection from personal liability. But from a tax perspective, a one-member LLC is treated as a disregarded entity. In this case all of the income and expenses are reported on Schedule-C and hence for federal income tax purposes, the LLC is treated as a sole proprietorship.

      Partnerships and Limited Liability Companies

      If you go into business with others you are automatically considered a partnership unless an S-Corporation or a C-Corporation election is made. There are two types of partnerships: general partnerships and limited partnerships. In general partnerships, all of the partners are personally liable for the debts of the business. In limited partnerships (LPs), only the general partners are personally liable for the debts of the business.

      Partnerships can be informal agreements to share profits and losses of a business venture. More typically, however, they are organized with formal partnership agreements. These agreements detail how income, deductions, gains, losses, and credits are to be split and what happens on the retirement, disability, bankruptcy, or death of a partner.

      An LLC formed under state law, which gives limited liability to all owners. Owners of limited liabilities are called members. LLCs for accountants, attorneys, doctors, and other professionals are called limited liability partnerships (LLPs). Some states such as Delaware, Illinois, Iowa, Oklahoma, Tennessee, Utah, and Wisconsin permit multiple LLCs to operate under a single LLC umbrella called a series LLC. The debts and liabilities of each LLC remain separate from those of the other LLCs.

      As the name suggests, the creditors of LLCs can look only to the assets of the company to satisfy debts; creditors cannot go after members and hope to recover losses from personal assets. For federal income tax purposes, LLCs are treated like partnerships unless the members elect to have the LLCs taxed as corporations. If a corporate election is not made on IRS Form 8832 then it is assumed the LLC is to be taxed as a partnership. A single-member LLC is treated for tax purposes like a sole proprietorship if the income and expenses are reported by its owner on Schedule-C.

      Partnerships and LLCs are pass-through entities. They are not separate taxpaying entities; instead, they pass income, deductions, gains, losses, and tax credits through to their owners. The owner reports these on their individual returns. While the entity does not pay taxes, it must file an information return with IRS Form 1065, U.S. Return of Partnership Income, to report the total pass-through amounts. The entity also completes Schedule K-1, a copy of which is given to each owner. The K-1 tells the owner his or her allocable share of partnership/LLC amounts.

      Separately stated are the stand-alone items that pass through to owners apart for the income. These are items that are subject to limitations on an individual’s tax return and must be segregated from the net amount of business income. Charitable contributions made by the partnership/LLC passes through separately as a charitable contribution. The partner adds the amount of the pass-through charitable contribution to his or her other charitable contributions. Other such items include capital gains and losses, Section 179 (first-year expensing) deductions, investment interest deductions, and tax credits.

      Losses are subject to limitations and the owner may not be able to claim the entire loss. The loss is limited by the owner’s basis or the amount of cash and property contributed to the partnership, in the interest in the partnership. Additionally, if you are a passive investor—a silent partner—in these businesses, your loss deduction is further limited by the passive activity loss rules. In general, these rules limit a current deduction for losses from passive activities to the extent of income from passive activities. Additionally, losses are limited by the individual’s economic risk in the business.

      S Corporations

      S corporations are like regular corporations (called C corporations) for business law purposes. They are considered separate entities and exist independently from their owners. The only difference between S corporations and other corporations is their tax treatment for federal income tax purposes.

      For the most part S corporations are treated as pass-through entities for federal income tax purposes. State law can vary on the treatment of S corporations with respect to income tax.

      To be eligible for an S election, the corporation must meet certain shareholder requirements. There can be no more than 100 shareholders. For this purpose, all family members up to six generations are treated as a single shareholder. Only certain types of trust are permitted to be shareholders. There can be no nonresident alien shareholders.

      For tax purposes, S corporations, like partnerships and LLCs, are pass-through entities and pass through to their shareholders income, deductions, gains, losses, and tax credits. The IRS reporting form is an 1120S, U.S. Income Tax Return for an S Corporation.

      Unlike partnerships and LLCs, however, S corporations may become taxpayers if they have certain types of income. There are only three types of income that result in a tax on the S corporation. These three cannot be reduced by any deductions:

      1. Built-in gains. These are gains related to appreciation of assets held by a C corporation that converts to S status.

      2. Passive investment income. This is income of a corporation that has earnings and profits from a time when it was a C corporation. A tax on the S corporation results only when this passive investment income exceeds 25 percent of gross receipts.

      3. LIFO (Last-In-First-Out) recapture. When a C corporation uses last-in, first-out or LIFO to report inventory converts to S status, there may be recapture income that is taken into account partly on the C corporation’s final return, but also the S corporations’s return.

      C Corporations

      A C corporation is an entity separate and apart from its owners; it has its own legal existence. For federal tax purposes, a C corporation is a separate taxpaying entity and files IRS Form 1120, U.S. Corporation Income Tax Return to report income or losses. Shareholders do not report their share of the corporation’s income.

      Personal Service Corporations

      Professionals who incorporate their practices are a special type of C corporation called personal service corporation (PSCs). These are considered to be a C corporation that performs personal services in the fields of health, law, accounting, engineering, architecture, actuarial science, performing arts, or consulting and meets certain ownership and service tests.

      In general, distributions from the C corporation to its shareholders are in the form of salary or dividends. Salaries are deductible against corporate income and dividends are not deductible. The shareholder reports both salary and dividend as income. This is commonly referred to as double taxation. First, earnings are taxed at the corporate level. Then, when they are distributed to the shareholders as dividends, they are taxed again, this time at the shareholder level. The current tax rate on dividends is 15%.

      In view or the favorable corporate rate tax structure, certain tax penalties prevent businesses from using this form of business organization to optimum advantage.

      1. Personal holding company penalty. Corporations that function as a shareholder investment portfolio rather than as an operating company may fall subject to the personal holding corporation (PHC) penalty tax of 15 percent on certain undistributed corporate income.

      2. Accumulated earnings tax. Corporations may seek to keep money in corporate accounts rather than distribute it as dividends to shareholders with the view that an eventual sale of the business will enable shareholders to extract those funds at capital gain rates. Unfortunately, the tax law imposes a penalty on excess accumulations at 15%. Excess accumulations are those above an exemption amount plus amounts for the reasonable needs of the business.

      For tax purposes, they are subject to special rules such as:

      1. They cannot use

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