entity

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.

 

For-profit vs. not-for-profit: Compare and contrast financial reporting goals

As the term suggests, for-profit companies are driven primarily by one goal — to maximize profits for their owners. Nonprofits, on the other hand, are generally motivated by a charitable purpose. Here’s how their respective financial statements reflect this difference.

Reporting revenues and expenses

For-profits produce an income statement (also known as a profit and loss statement), listing their revenues, gains, expenses and losses to evaluate financial performance. They report mainly on profitability and increasing assets, which correlate with future dividends and return on investment to owners and shareholders.

By comparison, not-for-profit entities just want revenue to cover the costs of fulfilling their mission now and in the future. They often rely on grants and donations in addition to fees for service income. So they prepare a statement of activities, which lists all revenue less expenses, and classifies the impact on each net asset class.

Many nonprofits currently produce a statement of functional expenses. But a new accounting standard kicks in this year — Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities. It will require organizations to classify expenses by nature (meaning categories such as salaries and wages, rent, employee benefits and utilities) and function (mainly program services and supporting activities). This information will need to be expressed in a grid format that shows the amount of each natural category spent on each function.

Balance sheet considerations

For-profit companies prepare a balance sheet that lists the owner’s or shareholders’ equity, which is based on the company’s assets, liabilities and prior profits. The equity determines the value of a company’s common and preferred stock.

Nonprofits, which have no owners, prepare a statement of financial position. It also looks at assets, liabilities and prior earnings. The resulting net assets historically have been classified as 1) unrestricted, 2) temporarily restricted, or 3) permanently restricted, based on the presence of donor restrictions. Starting in 2018 for most not-for-profits, the new accounting standard will reduce these classes to two: 1) net assets without donor restrictions and 2) net assets with donor restrictions.

Footnote disclosures

Another key difference: Nonprofits tend to focus more on transparency than for-profit businesses do. Thus, their financial statements and footnotes include a lot of disclosures, such as about the nature and amount of donor-imposed restrictions on net assets. Starting in 2018, ASU No. 2016-14 will require more disclosures on the amount, purpose and type of board designations of net assets. Additional disclosures will be required to outline the availability and liquidity of assets to cover operations in the coming year.

Common denominator

Whether operating for a profit or not, all entities have a common need to produce timely financial statements that stakeholders can trust. Contact us for help reporting accurate financial results for your organization.

© 2018

DOES YOUR PARTNERSHIP OR LLC AGREEMENT NEED TO BE AMENDED BY DECEMBER 31, 2017?

by Harold F. Ingersoll, CPA/ABV/CFF, CVA, CM&AA

Partner at Atchley & Associates, LLP

 

Partnerships and many LLCs file partnership income tax returns.  As a result of the Bipartisan Budget Act of 2015 (“BBA”), the IRS has new audit rules for entities that file partnership income tax returns beginning January 1, 2018.  These audit rules significantly change the regime that currently governs partnership tax audits, assessments and collections.

The condensed version of the changes is, in the past when a partnership was audited, the IRS pushed the adjustments through to the partners of the partnership who were partners in the year under audit.  The new rules allow the IRS to charge the tax, due to audit adjustments, directly to the partnership and the current partners.

Your first thought may be, why could this be a problem?  Well, let’s assume you bought into a partnership in 2017, and shortly thereafter the partnership is audited by the IRS for 2015 and there is an adjustment that causes there to be more taxes paid.  Under the new rules you would likely be paying the tax for the partners that were owners in 2015.

To solve this problem, you can make changes to your partnership or LLC member agreement.  Partnerships with 100 or fewer partners that meet certain other requirements may be eligible to elect to opt out of these rules.  For partnerships or LLCs that qualify for this “opt out”, the partnership agreements could be modified to make the “opt out” mandatory.

Another change with the BBA is the term of “Tax Matters Partner” is eliminated.  The new term is “Partnership Representative”.  The partnership or LLC agreement could be changed to reflect how the Partnership Representative will be selected, removed or replaced.  You may also consider limiting the Partnership Representative’s authority over certain tax matters, such as extending a statute of limitations or settling the dispute.

There is also a new election labeled the “Push Out Election”.  As it sounds this allows the partnership or LLC to push out any audit adjustments to prior year partners.  This election is not automatic and must be elected within 45 days of receiving the final notice of partnership adjustment.  The requirement to make this election can be documented in the partnership or LLC agreement.

The IRS has put us on notice that we can expect to see more partnership and LLC audits than in the past.  Consulting your advisors about the issues raised in the BBA will leave you prepared for any audit in which your partnership may be involved.

 

 

 

How entity type affects tax planning for owner-employees

Come tax time, owner-employees face a variety of distinctive tax planning challenges, depending on whether their business is structured as a partnership, limited liability company (LLC) or corporation. Whether you’re thinking about your 2016 filing or planning for 2017, it’s important to be aware of the challenges that apply to your particular situation.

Partnerships and LLCs

If you’re a partner in a partnership or a member of an LLC that has elected to be disregarded or treated as a partnership, the entity’s income flows through to you (as does its deductions). And this income likely will be subject to self-employment taxes — even if the income isn’t actually distributed to you. This means your employment tax liability typically doubles, because you must pay both the employee and employer portions of these taxes.

The employer portion of self-employment taxes paid (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible above the line. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income and modified adjusted gross income, which are the triggers for certain additional taxes and phaseouts of many tax breaks.

But flow-through income may not be subject to self-employment taxes if you’re a limited partner or the LLC member equivalent. And be aware that flow-through income might be subject to the additional 0.9% Medicare tax on earned income or the 3.8% net investment income tax (NIIT), depending on the situation.

S and C corporations

For S corporations, even though the entity’s income flows through to you for income tax purposes, only income you receive as salary is subject to employment taxes and, if applicable, the 0.9% Medicare tax. Keeping your salary relatively — but not unreasonably — low and increasing your distributions of company income (which generally isn’t taxed at the corporate level or subject to employment taxes) can reduce these taxes. The 3.8% NIIT may also apply.

In the case of C corporations, the entity’s income is taxed at the corporate level and only income you receive as salary is subject to employment taxes, and, if applicable, the 0.9% Medicare tax. Nevertheless, if the overall tax paid by both the corporation and you would be less, you may prefer to take more income as salary (which is deductible at the corporate level) as opposed to dividends (which aren’t deductible at the corporate level, are taxed at the shareholder level and could be subject to the 3.8% NIIT).

Whether your entity is an S or a C corporation, tread carefully, however. The IRS remains on the lookout for misclassification of corporate payments to shareholder-employees. The penalties and additional tax liability can be costly.

As you can see, tax planning is extra important for owner-employees. Plus, tax law changes proposed by the President-elect and the Republican majority in Congress could affect tax treatment of your income in 2017. Please contact us for help identifying the ideal strategies for your situation.

© 2016