business

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.

 

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

New tax law impacts M&A in a way you would not expect

I wanted to give you a heads up in the case you had not already seen this that the new tax law has a hidden issue related to M&A.  Since it is so new there is no Code section to refer to, but Paragraph 1504 of the new law adds to the list of assets that are excluded from the definition of capital assets.

 

Prior law excluded copyrights, literary, musical, or artistic compositions, letters or memoranda, or similar property from the definition of a capital asset if the asset is held either by the taxpayer who created the property, or a taxpayer for whom the property was produced.  Seldom in M&A do we see these assets being transferred.  The new law however changes this considerably.  The new law adds to this list patents, inventions, model or design, and a secret formula or process which is held by the taxpayer who created the property (or for whom the property was created).

The added items are encountered many time in the sale of a business.  The problem is that these items are intangibles and the value of these items have, historically been included in the portion of the purchase price that is allocated to goodwill.  Goodwill is a capital asset, and therefore subject to capital gains tax, whereas the previously mentioned items are not capital assets if the sale occurs in 2018 or later and must be excluded from goodwill value.  This give us an opportunity and creates some danger.  The opportunity is now we have another category of purchase price we can negotiate, the danger is if we do not separately state the allocation to these assets and they accidentally end up in the goodwill allocation the IRS could, upon audit make a sizable adjustment for the portion of the goodwill that they deem to be the value of these excluded items.  Fair Market Value in a sale between unrelated parties is whatever they agree upon.  If they do not agree then the IRS will have the ability to create a value.  In most cases the value of a business in excess of the value of its tangible personal or real property is considered “goodwill”.  This represents the value of the cash flow in excess of the tangible asset value.  If the business makes its money from the production of a product that has a patent or uses a secret formula then much of this excess value may actually be attributable to the patent or secret formula, which would render that portion of the purchase price subject to ordinary income tax rates and not be treated as capital gains.  If the value of these excluded assets are separately stated and the value is agreed to in the purchase agreement the IRS would have a hard time adjusting it.

The bottom line is if the business possesses any of the excluded assets it would be wise to allocate a negotiated portion of the purchase price to this class of assets.

Let me know if I can help further.

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

Partner at Atchley & Associates, LLP

How to maximize deductions for business real estate

Currently, a valuable income tax deduction related to real estate is for depreciation, but the depreciation period for such property is long and land itself isn’t depreciable. Whether real estate is occupied by your business or rented out, here’s how you can maximize your deductions.

Segregate personal property from buildings

Generally, buildings and improvements to them must be depreciated over 39 years (27.5 years for residential rental real estate and certain other types of buildings or improvements). But personal property, such as furniture and equipment, generally can be depreciated over much shorter periods. Plus, for the tax year such assets are acquired and put into service, they may qualify for 50% bonus depreciation or Section 179 expensing (up to $510,000 for 2017, subject to a phaseout if total asset acquisitions for the tax year exceed $2.03 million).

If you can identify and document the items that are personal property, the depreciation deductions for those items generally can be taken more quickly. In some cases, items you’d expect to be considered parts of the building actually can qualify as personal property. For example, depending on the circumstances, lighting, wall and floor coverings, and even plumbing and electrical systems, may qualify.

Carve out improvements from land

As noted above, the cost of land isn’t depreciable. But the cost of improvements to land is depreciable. Separating out land improvement costs from the land itself by identifying and documenting those improvements can provide depreciation deductions. Common examples include landscaping, roads, and, in some cases, grading and clearing.

Convert land into a deductible asset

Because land isn’t depreciable, you may want to consider real estate investment alternatives that don’t involve traditional ownership. Such options can allow you to enjoy tax deductions for land costs that provide a similar tax benefit to depreciation deductions. For example, you can lease land long-term. Rent you pay under such a “ground lease” is deductible.

Another option is to purchase an “estate-for-years,” under which you own the land for a set period and an unrelated party owns the interest in the land that begins when your estate-for-years ends. You can deduct the cost of the estate-for-years over its duration.

More limits and considerations

There are additional limits and considerations involved in these strategies. Also keep in mind that tax reform legislation could affect these techniques. For example, immediate deductions could become more widely available for many costs that currently must be depreciated. If you’d like to learn more about saving income taxes with business real estate, please contact us.

© 2017

Changes to I-9 Employment Eligibility Verification Form

Effective September 18, 2017, the U.S. Citizenship and Immigration Services (USCIS) released a revised version of Form I-9, Employment Eligibility Verification. Federal law requires that this form be used by any employer to ensure and verify your employee’s identity and employment authorization.

What are some of the revisions made to Form I-9?

  • Instructions for Form I-9 have been updated
  • List C – Documents that Establish Employment Authorization has been changed

Some things to consider with this newest form:

  • Employers must being using this newest version of Form I-9 [Form I-9 07/17/17 N]. All previous versions of I-9 after 09/19/17 will not be valid.
  • For any current employees, the previously completed Form I-9 on file will be valid.

For a complete list of formats and instructions available for I-9, please visit the USCIS website: www.uscis.gov/i-9.