Month: May 2018

Top 5 tips for small business owners

by Alvin Wu, CPA

Tax Manager at Atchley & Associates, LLP

 

Top 5 Tips for Small Business Owners

1. Decide on entity structure

When a business outgrows a schedule C, generally, it’s beneficial for small business owners to elect to be a S corporation or a partnership (LLP, LP, LLC etc.) depending on the number of business owners in the entity.  Partnerships normally require at least two partners while S corporations can have one.  One of the main advantages of these two structures are that there is a single level of taxation on the individual return and no tax on the business return.   A corporation on the other hand taxes business owners first on the corporation’s return (21% starting in 2018) and then again on the individual owner’s return when they receive any dividends from the corporation.

2. Keep personal finances separate

It is crucial to have a business checking account to keep personal funds separate from the business.  This makes things easier when creating any cash reconciliations schedules or financial statements, which will inevitably be needed as the business grows.  Future in house or third-party accountants will also have an easier time utilizing the business’s financial records if there are no comingled personal funds, which in turn will save the business owner on fees.

3. Keep a record of any travel expenses and meals

Unfortunately, entertainment expenses for clients was eliminated in the Jobs Act of 2017, however, meals where business is conducted is still 50% deductible.  In addition, travel for business remains 100% deductible.  Keeping an accurate record of these expenses can reduce any tax liability.

4. Take advantage of the de minimis safe harbor

Furniture and equipment with useful life greater than 1 year is required to be capitalized, which forces businesses to only recognize a fraction of the total cost as expense each year for the item’s useful tax life.  Tax years starting January 1st, 2016 and after, the IRS allows businesses and individuals to elect to fully expense items with a cost of less than $2,500.

5. Remember to take office in home deductions

Small business owners often work out of their home office.  The IRS allows business owners to either take the expenses on schedule A, or on the business’s return, assuming the business is no longer on a schedule C.  Keep accurate expense records and consult a tax advisor to optimize the tax benefits of reporting on the individual return vs the business return.

 

The TCJA changes some rules for deducting pass-through business losses

It’s not uncommon for businesses to sometimes generate tax losses. But the losses that can be deducted are limited by tax law in some situations. The Tax Cuts and Jobs Act (TCJA) further restricts the amount of losses that sole proprietors, partners, S corporation shareholders and, typically, limited liability company (LLC) members can currently deduct — beginning in 2018. This could negatively impact owners of start-ups and businesses facing adverse conditions.

Before the TCJA

Under pre-TCJA law, an individual taxpayer’s business losses could usually be fully deducted in the tax year when they arose unless:

  • The passive activity loss (PAL) rules or some other provision of tax law limited that favorable outcome, or
  • The business loss was so large that it exceeded taxable income from other sources, creating a net operating loss (NOL).

After the TCJA

The TCJA temporarily changes the rules for deducting an individual taxpayer’s business losses. If your pass-through business generates a tax loss for a tax year beginning in 2018 through 2025, you can’t deduct an “excess business loss” in the current year. An excess business loss is the excess of your aggregate business deductions for the tax year over the sum of:

  • Your aggregate business income and gains for the tax year, and
  • $250,000 ($500,000 if you’re a married taxpayer filing jointly).

The excess business loss is carried over to the following tax year and can be deducted under the rules for NOLs.

For business losses passed through to individuals from S corporations, partnerships and LLCs treated as partnerships for tax purposes, the new excess business loss limitation rules apply at the owner level. In other words, each owner’s allocable share of business income, gain, deduction or loss is passed through to the owner and reported on the owner’s personal federal income tax return for the owner’s tax year that includes the end of the entity’s tax year.

Keep in mind that the new loss limitation rules apply after applying the PAL rules. So, if the PAL rules disallow your business or rental activity loss, you don’t get to the new loss limitation rules.

Expecting a business loss?

The rationale underlying the new loss limitation rules is to restrict the ability of individual taxpayers to use current-year business losses to offset income from other sources, such as salary, self-employment income, interest, dividends and capital gains.

The practical impact is that your allowable current-year business losses can’t offset more than $250,000 of income from such other sources (or more than $500,000 for joint filers). The requirement that excess business losses be carried forward as an NOL forces you to wait at least one year to get any tax benefit from those excess losses.

If you’re expecting your business to generate a tax loss in 2018, contact us to determine whether you’ll be affected by the new loss limitation rules. We can also provide more information about the PAL and NOL rules.

© 2018

IRS Audit Techniques Guides provide clues to what may come up if your business is audited

IRS examiners use Audit Techniques Guides (ATGs) to prepare for audits — and so can small business owners. Many ATGs target specific industries, such as construction. Others address issues that frequently arise in audits, such as executive compensation and fringe benefits. These publications can provide valuable insights into issues that might surface if your business is audited.

What do ATGs cover?

The IRS compiles information obtained from past examinations of taxpayers and publishes its findings in ATGs. Typically, these publications explain:

  • The nature of the industry or issue,
  • Accounting methods commonly used in an industry,
  • Relevant audit examination techniques,
  • Common and industry-specific compliance issues,
  • Business practices,
  • Industry terminology, and
  • Sample interview questions.

By using a specific ATG, an examiner may, for example, be able to reconcile discrepancies when reported income or expenses aren’t consistent with what’s normal for the industry or to identify anomalies within the geographic area in which the taxpayer resides.

What do ATGs advise?

ATGs cover the types of documentation IRS examiners should request from taxpayers and what relevant information might be uncovered during a tour of the business premises. These guides are intended in part to help examiners identify potential sources of income that could otherwise slip through the cracks.

Other issues that ATGs might instruct examiners to inquire about include:

  • Internal controls (or lack of controls),
  • The sources of funds used to start the business,
  • A list of suppliers and vendors,
  • The availability of business records,
  • Names of individual(s) responsible for maintaining business records,
  • Nature of business operations (for example, hours and days open),
  • Names and responsibilities of employees,
  • Names of individual(s) with control over inventory, and
  • Personal expenses paid with business funds.

For example, one ATG focuses specifically on cash-intensive businesses, such as auto repair shops, check-cashing operations, gas stations, liquor stores, restaurants and bars, and salons. It highlights the importance of reviewing cash receipts and cash register tapes for these types of businesses.

Cash-intensive businesses may be tempted to underreport their cash receipts, but franchised operations may have internal controls in place to deter such “skimming.” For instance, a franchisee may be required to purchase products or goods from the franchisor, which provides a paper trail that can be used to verify sales records.

Likewise, for gas stations, examiners must check the methods of determining income, rebates and other incentives. Restaurants and bars should be asked about net profits compared to the industry average, spillage, pouring averages and tipping.

Avoiding red flags

Although ATGs were created to enhance IRS examiner proficiency, they also can help small businesses ensure they aren’t engaging in practices that could raise red flags with the IRS. To access the complete list of ATGs, visit the IRS website. And for more information on the IRS red flags that may be relevant to your business, contact us.

© 2018