S Corporations Archives

To Be, Or Not To Be an S-Corporation, THAT is the Question:

Whether ’tis Nobler in the mind to suffer the stings and angles of outrageous tax planning, or to take hold against a sea of tax pitfalls, and by addressing them : to not cry, to sleep more soundly.

As CPAs, we come across some pretty poor tax planning and accounting with new clients. Sometimes we had to amend tax returns prepared by another CPA.

Jose Zabrano, CPA addressed the need for better planning concerning the C-corp/S-corp question in How Changes in Corporate Tax Rates Can Affect Choice of C vs S Corp

Any time you make decisions of this type, you should always work with a CPA, but you should know the basic differences in the two types of tax designations:

Who pays the Taxes? Normally the main difference between the two is that C Corporations pay their own taxes at their own rates. (This of course is the main deciding factor in Jose’s article.) An S-corporation income or loss passes through to the shareholders’ individual returns where the taxes are paid at their rate.
Medical Deductions:We usually deal with closely-held or sing shareholder companies so medical deductions are an issue. C Corporations usually allow the owner shareholder to deduct their medical insurance and out of pocket medical costs. S Corporations do not with one exception: If 2% + (ownership) shareholders want to deduct their medical insurance deductions, they can if you do a tricky W-2 maneuver allowing them to take the deduction on their personal returns. As CPA s, we still struggle with payroll companies to get this right. This must be done by December of each year.
Tax Basis:Shareholders who want to deduct losses that pass through from their S-Corporations must be careful. In order to deduct these losses, you must have a “tax basis.” In other words, you must have “skin in the game.” In its most simplest form, what this means is that in most cases, you cannot deduct losses if your capital account is negative. As a CPA, we compute basis and at-risk calculations to determine if a loss is partially or totally deductible, or does it get carried forward.
Reasonable Compensation: What’s reasonable? “Reasonable” is what the IRS says is reasonable, so a CPA must consult you as to your salary and draws in an S Corporation. This is a hot button for the IRS because shareholders skirt paying payroll taxes on draws. C- corporations do not pay draws, but dividends which are taxed currently at capital gain rate if they qualify.

As CPA s we see a lot of the same mistakes in S Corporations and C Corporations. We stress that clients plan during the year so as to not have any surprises.

______________________________________________________________________________

IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the U.S. Department of the Treasury and Internal Revenue Service, we inform you that any tax advice contained in this e-mail (including any attachments) is not intended or written to be used, and may not be used, for the purpose of (a) avoiding penalties under the Internal Revenue Code or state tax authority, or (b) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

S-Corporations: Watch out for those Glacier Crevasses

Have you ever watched a mountain climbing movie or documentary where they have to cross a glacier that is covered with snow. The climbers move at a snail’s pace checking the ground in front of them for a hidden crevasse. One bad step and they can drop a hundred feet into a icy grave. Certainly not the environment for a mild mannered CPA.

Maybe this is too dramatic for operating an S-corporation, but the wrong moves can send you plummeting into tax despair. Here are a few CPA tips if you are a closely held company:

Make a timely and valid election. The IRS has eased up on the deadlines for S-corporation elections, but don’t take them for granted. Always make your elections timely, and if not, try to fit into one of the exceptions that gives you a grace period.
Pay yourself a reasonable salary. As CPA’s we see many owners trying to take a disproportionate amount of draws as opposed to salary. The IRS doesn’t like this because the owner/officer is skipping out on paying FICA and medicare withholding. Make sure your salary is reasonble for the service you are providing.
Report medical insurance deductions properly. A 2% + owner cannot deduct the medical insurance in its S-corporation. There is a tricky manuever that you have to add the insurace to your W-2; deduct it as part of your salary; lastly take the insurance as a self-employment health insurance deduction on your personal return. It usually takes a CPA to discuss this with your payroll service.
Don’t Be Second Class. S-corporations cannot have more than one class of stock. Do not inadvertantly create a second class stock by having different voting rights, or disproportional draws.
Watch out for your Tax Basis when Deducting a Loss. Just because you have a loss does not mean you can take it. You must have a tax basis to do so. In other words, you cannot take out more losses than what you have invested plus profits. The basis calculation should be updated every year.
Have your CPA plan your tax strategy each year. We find many new clients whose CPA’s ignore the S-corporation in tax planning. You must dive into it during the year, not March of the following year.

These might seem tough, but your CPA should automatically monitor the things above. To not do so could present shocking surprises in April. Check with your CPA before implementing any of these points.

______________________________________________________________________________

CPA Reminder: 2012 Self-employed Healthcare Credit

Yes, I know. Health insurance is very high and a drag on the small business. So, lessen the pain by taking the healthcare credit if you qualify. Here are the facts:

Starting in tax year 2011, you take the credit on Form 1040.

However, you must be one of the following to qualify:

A self-employed individual with a net profit reported
on Schedule C (Form 1040), Profit or Loss From Business, Schedule C-EZ
(Form 1040), Net Profit From Business, or Schedule F (Form 1040), Profit
or Loss From Farming.
A partner with net earnings from self-employment
reported on Schedule K-1 (Form 1065), Partner’s Share of Income,
Deductions, Credits, etc., box 14, code A.
A shareholder owning more than 2 percent of the
outstanding stock of an S corporation with wages from the corporation
reported on Form W-2, Wage and Tax Statement. This last situation catches clients off guard because they have to do an odd adjustment to their W-2. Our bookkeepers work with clients to properly report their payroll. If you did not properly include the health insurance in your W-2, then you should amend it.

The insurance plan must be established under your business.

For self-employed individuals filing a Schedule C,
C-EZ, or F, the policy can be either in the name of the business or in the
name of the individual.
For partners, the policy can be either in the name of
the partnership or in the name of the partner. You can either pay the
premiums yourself or your partnership can pay them and report the premium
amounts on Schedule K-1 (Form 1065) as guaranteed payments to be included
in your gross income. However, if the policy is in your name and you pay
the premiums yourself, the partnership must reimburse you and report the
premium amounts on Schedule K-1 (Form 1065) as guaranteed payments to be
included in your gross income. Otherwise, the insurance plan will not be
considered to be established under your business.
For more-than-2-percent shareholders, the policy can be
either in the name of the S corporation or in the name of the shareholder.
You can either pay the premiums yourself or your S corporation can pay
them and report the premium amounts on Form W-2 as wages to be included in
your gross income. However, if the policy is in your name and you pay the
premiums yourself, the S corporation must reimburse you and report the
premium amounts on Form W-2 as wages to be included in your gross income.
Otherwise, the insurance plan will not be considered to be established
under your business.

If this in confusing, speak to your CPA. The deduction is too good to pass up.

IRS Source

______________________________________________________________________________

Where Do We Go From Here? Strategic Planning In the Fog

The yellow bus lights glowed in the dark as my only beacon. I couldn’t see 20 feet in front of me on Highway 99 in the central California valley, but we had to get to Lake Huntington. The four cars packed with my companions followed my lead. At last, I saw the exit. Moving off the highway onto a dark farm road, my concern peaked. Where were the street signs behind the foggy shrouds? At last I stopped at an intersection and was able to see a sign, but only after I stood in the middle of a dark intersection looking almost straight up.

If you have been planning for the last three years, this story should sound like your attempt to plan strategically. Hugh Courtney’s Strategy under uncertainty lends us a flare in such dismal times. He offers a four-level framework for determining the level of uncertainty surrounding strategic decisions and for tailoring strategy to the uncertainty:

Level one: A clear enough future: Courtney states that managers can use the usual strategy tools in a clearer future as this. However, I see that medium and small businesses do not know what those tools are. The biggest private producers of jobs in this country, small business, usually work in a strategy void. Thus their decisions and plans are usually uninformed and a product of crises management even in the best of times.

Level two: Alternative futures: Outcomes are clear by hard to predict. Take the Ford Edsel, for example. The car seemed like a good strategy with a ready market, but it went the way of the do-do bird. This is where probability analysis can come in according to Courtney. For small businesses, look at the downside to each alternative. Is one downside greater? You may want to go the other way.

Level three: A range of futures:Taking Courtney’s cue, small businesses must limit their strategic options. Don’t take the shotgun approach and consider ten different strategies, for example, because you can. Your brain will explode, not a pretty site. Again, focus on the downside of your options.

Level four: True ambiguity: This option happens in an economic free-fall, or at least a controlled fall. More than ever, I recommend small business to take a Blue Ocean Strategy viewpoint and focus on the needs of your clients. Eliminate those attributes that your industry is providing clients that they can live with, e.g., meals on a commuter flight. You can take this approach for any other above levels, but at this level, it is usually a matter of survival. The wrong decision could land you in bankruptcy very quickly.

If You Are Reading This, You’ve Proved My Point

Last January, I again participated on the planning committee for the 2011 Entertainment Industry Conference for CPAs and attorneys. We agreed on most of the usual topics to be presented at the conference. Then, I suggested social networking. The idea was written on the board.

Fifteen minutes later, a respectible CPA turned to me and said, “Rick, I know social networking is a sexy topic, but I doubt it is what our attendees are looking for. They won’t come away with anything.” I nodded my head and thought to myself: Thank you. You just gave me an extra 12 months to blow my competition out of the water using social networking and SEO.

Skeptical? 5 Key Social Media Findings That Affect Your Business by Glen Stansberry lists some new findings:

1. Americans spend most of their time online on social network and blogs–If you are reading this blog, you have contributed to the 23% statistic that more time is used reading blogs and social networks than checking emails. You may have also found me because of what I have been doing for over a year. Writing

2. Seventy percent of active online adult social networkers shop online–Sell where your buyers live, online. We are all going there. Have a bigger presence than your competition.

3. Fifty-three percent of active adult social networkers follow a brand(only 32 percent follow a celebrity)–Adults follow brands across social networks.

4. Sixty percent of social media users create reviews of products or services–When was the last time you reviewed a book on Amazon, or rated a restaurant on Opentable? You are contributing the movement. If your business is not on there, then you are behind the curve.

5. The number of mobile Internet users is up 47 percent from last year–I have actually trashed a rude restaurant that made us wait an hour beyond their seating estimate. We were outside with our 85 year old father-in-law on Father’s Day in the dark. My bad review went into Yelp before I reached my car in the parking lot.

If you are resisting the social network, SEO revolution, you are risking the well-being of your business. But, before you jump in, do some research and learn. There are consultants that can help you. Then, create a strategy and stick to its implimentation. Your online presence will not increase overnight, but the constant creation of content will get you noticed.

Small Business Promotion Using Social Media–How We Did It

I couldn’t believe it. Well, actually I could, but I didn’t want to. Gregg Towsley of WSI Quality Solutions sat down with me me 18 months ago and showed me that my business’s social profile was dead. In other words, if you typed in industry key words, we didn’t even show up on ANY page.

I came across What Drives Small Business Social Media Engagement? by Dan Schawbel. He cited a study by Roost which offered advice to small business owners who want to create brand awareness, customer, acquisition, and customer services.

Using only Facebook and Twitter, the study suggested the following:

Publishing photos: The study suggested photos of employees, products, and functions. I remember when I first put up our web page, our most valuable search term was my assistant Maddy Curley. She was an actress that had (and has) some success on television and film. People googled her after seeing her on a TV episode and came up with her picture on our personnel page.
Ask Questions:Start a discussion by asking questions. You see this a lot on LinkedIn. I feel that providing information along with questions is a better strategy. What do you think?
Share Quotes:There are way too many twitter sites and blogs quoting wise people. I don’t like to. I find it is far more interesting to coin my own phrases that display my expertise. You don’t convince others of you knowledge and wisdom by using someone else’s brain. (You can quote that).

The main activity that got our firm on the front Google page ahead of CPA firms much larger than us is our content and consistency. To be successful, you must give to the business community. We provide advice and steps to individual businesses that can help them in managing their finances.

2010 Small Business Tax Breaks Revisited

It’s always good to practice the basics, like a major league baseball player who may work on his swing by hitting a ball off a tee. So here I am going back to the IRS tax site to remind small business owners of the Tax Relief Act of 2010. There may be benefits that you may be missing.

Sect. 2011: Temporary exclusion of 100% of gain on certain small business stock

Expanding on the provisions of Internal Revenue Code Section 1202 and the American Recovery and Reinvestment Act, the Small Business Jobs Act provides an additional incentive for investment in qualified small businesses. Under this Act, investors in qualified small business stock can exclude up to 100% of the capital gain upon sale of the stock.

Under the SBJA, in order to claim the capital gain exclusion, the qualified small business stock must be:

Acquired after September 27, 2010, and before Jan 1, 2011, and
Held for at least five years before the stock is sold.

However, Section 760, Temporary Exclusion of 100% of Gain on Certain Small Business Stock, of the Tax Relief Act of 2010, extended the exclusion for qualified small business stock acquired before January 1, 2012.

Under current law, the earliest tax year for which this 100% capital gain exclusion can be claimed is 2015. Additional limitations, qualifications and requirements may apply. Capital Gains and Losses has information on reporting capital gains.

Sect. 2012: General business credits of eligible small businesses for 2010 carried back 5 years

The new law allows an eligible small business to carry back general business credits five years. Previously, the credits could only be carried back one year. The carryback is for credits determined in the first taxable year beginning after December 31, 2009.

An “eligible small business” in general is defined as follows:

A corporation whose stock is not publicly traded, a partnership, or a sole proprietorship, and
The taxpayer must have $50,000,000 or less in average annual gross receipts over the three preceding tax years.

This is a one year initiative applicable only to the tax year 2010 (For fiscal year filers, the effective tax year is the first tax year beginning after December 31, 2009). The five-year carryback period is available only for credits carried forward to the tax year 2010 and/or earned in the tax year 2010.

Sect. 2013: General business credits of eligible small businesses in 2010 not subject to alternative minimum tax

The new law allows general business credits to offset both regular income tax and alternative minimum tax of eligible small businesses as described in Section 2012 of the Small Business Jobs Act (see above). The provision is effective for any general business credits determined in the first taxable year beginning after December 31, 2009, and to any carryback of such credits.

This is a one year initiative applicable only to the tax year 2010 (For fiscal year filers, the effective tax year is the first tax year beginning after December 31, 2009).

Sect. 2014: Temporary reduction in S-Corporation built-in gain recognition period

Under the Small Business Jobs Act, if the fifth year of an S Corporation’s recognition period ends before their 2011 taxable year begins, then no entity-level tax is imposed on the net recognized built-in gain for the 2011 tax year. Sect. 2021: Increased expensing limitations for 2010 and 2011; certain real property treated as Code section 179 property.

An expense deduction is allowed for businesses which choose to treat the cost of certain qualified property, called section 179 property, as an expense rather than a capital expenditure. For qualifying property placed in service during the taxable years 2010 and 2011, the new law increases both the maximum amount of the deductible expense under IRC Section 179, as well as the statutory phase-out amount. The provision also expands the definition of IRC Section 179 property to include the following types of real property: qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property.

Sect. 2022: Additional first-year depreciation for 50% of the basis of certain qualified property

Generally, businesses are allowed to recover the cost of capital expenditures over time through depreciation expense. IRC Section 168(k) allows for additional first-year depreciation, for 50% of the basis, of certain qualified property placed in service after December 31, 2009. The new law extends the additional first-year depreciation deduction to qualified property acquired and placed in service during 2010.

Section 401, Extension of Bonus Depreciation, of the Tax Relief Act of 2010, expands the additional first-year depreciation deduction (bonus depreciation) to equal 100 percent of the cost of qualified property placed in service after September 8, 2010, and before January 1, 2012. It also provides for a 50 percent first-year bonus depreciation deduction for qualified property placed in service after December 31, 2011 and before January 1, 2013.

Sect. 2031: Increase in amount allowed as deduction for start-up expenditures in 2010

For taxpayers starting an active trade or business, the new law increases the amount the taxpayer is allowed to elect as a deduction for start-up expenditures under section 195(b) for taxable years beginning after December 31, 2009. Section 2031 allows up to $10,000 as a deduction for start-up expenditures, but requires a dollar-for-dollar reduction of the $10,000 deduction if startup expenditures exceed $60,000. This expense should be claimed as an “Other Deduction” on business returns, such as the Form 1120, 1120S or 1065, or as an “Other Expense” on the Schedules C or F of the Form 1040. The remainder of any start-up expenditures, not deducted under section 195(b), can be amortized ratably over 180 months on Form 4562, Depreciation and Amortization.

Sect. 2042: Deduction for health insurance costs in computing self-employment taxes in 2010

Generally, small business owners may not deduct the cost of health insurance when calculating self-employment tax. Under the Small Business Jobs Act, and subject to specific statutory restrictions (i.e. deduction is not available if self-employed individual is eligible to participate in an employer-subsidized health plan maintained by the employer of the taxpayer or the employer of the taxpayer’s spouse), business owners can deduct the cost of health insurance for themselves and their family in the calculation of their 2010 self-employment tax.

Always consult your tax professional before making any of these decisions.

______________________________________________________________________________

The Tightrope of Employee Tax Classification is Getting Frayed

My grandfather was Alfano the Great. In the 1920’s he walked between 2 eight story buildings with no net. In addition, he walked on his hands, rode a bicycle and did wheelies. All for a few bucks. Obviously, he never fell, or I wouldn’t be here.

The IRS, US Labor Department, and several state labor departments are about to cut the tight rope of some employers who classify employees as independent contractors.

Michael Cohen report, IRS to Team with Labor Dept. on Employee Classification, discusses the IRS and the Labor Dept. combine efforts with seven states to tackle the problem of employee tax classification. This could be a game-changer because one of the problems in employee tax classification has been defining what an “employee” is.

This move among all of these agencies (and I can only guess that the number of states signing on will grow), will allow a sharing of information about employee tax classifications. Now, this may seem harmless, but remember when you can operate a business in Los Angeles without a business license? Ten or fifteen years ago, one of the main ways L A City found you was to look at the business marques in buildings and cross-check them to the business license lists. Now, they get their information from Sacramento and individual tax return schedule C. All they do now is match the addresses to the individual tax return and send out penalty notices.

I have been writing about this issue for a long time. Here is an article in relation to the healthcare deduction. Healthcare Reform: If It Walks Like a Duck and Quacks Like a Duck…We’ll Call it a Toad

Employee tax classification databases may change the odds for those employers who are skirting the issue. The penalties could be stiff. Discuss your tax situation with your advisor before making any decisions.

______________________________________________________________________________

How Does a Small Business Grow? You Can Try to Think Like A Rock Band

We were called the Mini Playboys. Three ten year old musicians who temporarily put down their rock roots to play old standards, big band, and Italian songs. The band consisted of a drum, guitar, and accordion. We almost never played like this for our friends for the obvious reasons, but played at old folks parties and restaurants. Heck, we each earned $5.00 an hour in 1967 when minimum wage was $1.40. Great money! Our band focused on a strategy to hit a particular niche market, and it worked for 2 years until we went our separate ways.

I came across an article by Apryl Peredo, So, You Want a Label Contract? The article listed 5 reasons why bands are not signed by record labels. The article laid out some good, though basic advice to young band members. However, as I read the article I substituted the word “small business” for “band.” It also seemed to translate into good advice to those small businesses that are looking to grow their business. Here is what I mean:

We don’t sign “newly formed” bands. Customers who are looking for value and trust like to see an established business. This also pertains to expertise. I remember working for an accounting firm who declared themselves as experts in any area where they performed a single engagement. That hardly builds up the trust you want with your customers.
We don’t sign undeveloped bands.As a business owner, you must walk before you run. Starting small is not bad, it allows you to make mistakes without risking too much. Design your strategy to build slowly and in control or you may find yourself in the “white water” (Les McKeown’s definition in Predictable Success).
We don’t sign unknown bands. Customers and clients like to see a reputation, a good reputation. In looking at E-Bay, I noticed that some of the most successful businesses are those who have hundreds of good ratings. This weighs a lot with a new customer, so build your fan base.
We don’t sign people/band we meet at parties. Very few people would hire an attorney who advertised door to door. There is just a culture that discourages that kind of selling for that profession. It may work for a realtor, but not a surgeon. Learn your industry’s norms and culture.
We don’t sign based on “oral” favors. Business character counts. Always be beyond reproach in your client solicitation practices.

The article summed up a band’s quest to secure a label contract with “persistence, practice, professionalism, creative development, and hard work”

That is good advice for any small business looking to grow. Very few businesses make it “big” over night, and the ones that seem like they do, worked at it for years.

Charismatic Business Leaders: What to do afterwards? A Problem to Be Avoided

I can remember back in the late 1970s when only engineers and escentrics operated an apple computer. My neighbor brought me over and tried to explain how the large odd-shaped device worked. MS-DOS was not invented, and my attention span waned.

Business has embraced many aspects of Apple, along with the consumer, driving it beyond Microsoft’s highest endeavours.

But what happens without Steve Jobs at the helm, and how does this series of events relate to small and medium-sized businesses?

Kathleen Pender speaks of this issue in Maintaining success after exit of a charistmatic CEO. However, she really is not addressing the right questions. Does a company need a charasmatic leader? Or, what kind of personl should lead a company?

Jim Collins writes about these in his two books, Good to Great and Built to Last. In Built to Last he states that visionary companies do not require great charismatic visionary leaders. “In fact, [they] can be detrimental to a company’s long-term prospects. Some of the most significant CEOs in the history of visionary companies did not fit the model of the high-profile, charismatic leader.”

In Good to Great, Jim states what kind of leaders should lead a company. Level 5 leadership during pivotal transitional years “refers to a five-level hierarchy of executive capabilities, with Level 5 at the top. Level 5 leaders embody a paradoxical mix of personal humility and professional will. They are ambitious, to be sure, but ambitous first and foremost for the company, not themselves.”

Steve Jobs seemed to fit this definition. He seemed to push the company, not himself which will help foster the Apple tradition long after he departs from it.

Small and medium-sized business owners should take note of this distinction. I find that so many owners sell their personas, not the company. This is almost fatal in two respects:

When the owner wants to sell the business.
When the owner dies.

In both cases, the inherent value of the company is tied to the owner, not the balance sheet. If he goes, it goes.

So, how do you get out of this vicious circle. I recommend:

Read the E-Myth by Michael Gerber. The author descrives the owner’s chokehold on a business, and why a business of that type struggles to grow.
Train, train, train others to do specific tasks that you perform. If you are worried about losing your customers to you employees, create a system of divided labor where each person performs specific tasks, but you still hold the key to putting it all together.
Set out a timeline for an exit plan. When do you plan to sell the busiess? How big does your business have to be before you sell it? What annual metrics can you measure to make sure you are on your path?

Quantify you feelings. Don’t dream of a company that you cannot measure its success or milestones. You can be a visionary, but the it is not about you, it is about your business.