Top Small Business Concerns

Someone recently asked me “what, in my opinion, are the top two or three biggest concerns of a small business?”  I couldn’t reply immediately but then gave it some thought. 

1)                       Act like a business!!!  Courts might pierce the corporate veil and impose personal liability if there is no real separation between the company and its owners.  If the owners fail to maintain a formal legal separation between their business and their personal financial affairs, a court could find that the corporation or LLC is really just a sham and that the owners are personally operating the business as if the corporation or LLC didn't exist. 

2)                       S-Corps…Make sure that you pay “Reasonable Shareholder Compensation.”  The IRS requires that business owners that perform substantial services to their business be paid a salary according to several factors.  This is called reasonable compensation.  You can’t pay yourself below market and take a large amount in distributions. 

3)                       S-Corps…Keep track of your basis in your business.  Two problems arise when shareholders do not have basis in their entity:

                                      i.      Current year losses are not allowed to be deducted on your personal tax return.

                                    ii.      Distributions to shareholders who do not have basis in their entity are not tax free.  They are converted into long term capital gain and taxed at the capital gain tax rates. 

4)                       There is a difference between an employee and a contractor.  There are many factors to determine this but, if you have control over what, when, where and how a person performs work for you, the that person is an employee. 

                                      i.      Generally, you must withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages paid to an employee.

                                    ii.      You do not generally have to withhold or pay any taxes on payments to independent contractors. 

Which leads me into my last important issue.  Make sure that you obtain the proper documentation for both employees and contractors at the beginning of your relationship.  You will need it when you prepare their W-2 or 1099. 

There are so many other important issues but, these are the ones that I run into most in my practice. 

S Corporations and Reasonable Compensation

I want to remind S Corporation shareholders of their responsibility to accurately determine and document Reasonable Compensation for services provided to your business.  Reasonable Compensation is the salary or wages that you, a shareholder-employee of an S Corp, pay yourself for the work you perform for your company.

The IRS requires that all shareholders of S Corps who perform services for their company pay themselves Reasonable Compensation, and it should be paid prior to taking any distributions.  You should be aware that under Rev. Rul. 74-44, the IRS will re-characterize distributions paid to shareholders as salary when such distributions are paid in lieu of reasonable compensation. 

There are two ways to think about Reasonable Compensation:

1.      Replacement Cost:  What would it cost your company to pay someone else to provide all the services you currently provide?

2.      Fair Market Value:  What would other businesses in your community pay you for the services you currently provide to your company?

The key to establishing reasonable compensation is determining what you do for your S Corporation.  In addition to direct generation of revenue, you should also compensate yourself for administrative work.  It is important that you research and document how you reach your Reasonable Compensation figure.

We are here to assist you with this issue and have tools available that can help you accurately determine your Reasonable Compensation figure.  Please contact us if you would like to discuss this issue further or to have me prepare a Reasonable Compensation Report for you.

A Reasonable Compensation Report is a detailed report that establishes your Reasonable Compensation using criteria outlined by the IRS.  To generate a Reasonable Compensation report we would complete a short interview (15-20 minutes).  When complete, we will go over the report and make any needed changes before locking in your Reasonable Compensation figure.

The best time to establish your Reasonable Compensation figure is now, before an IRS examination.  Reasonable Compensation has become an IRS hot button and we have been told to expect an increase in examinations of S Corps.  Completing a Reasonable Compensation Report is easy and provides a defensible position to an IRS challenge.

If you are currently taking a salary, it may be time to revisit it to determine that it is reasonable.  If you are not currently taking a salary from your S Corp. then it quite possibly may be time to start. 

If you are interested, please contact us so that we can discuss this issue further.

Lessons from H&R Block

OK…I’ve had it with all of the H&R Block ads telling everyone on TV to “Get Your Billions Back.”  If their clients are getting refunds of that size, then their tax planning is all wrong.  Block even have an anti- CPA YouTube video - https://www.youtube.com/watch?v=AJcBK1DCrbo

I have seen the following from H&R Block over the past year alone:

·         A corporate client had me review their Block prepared individual tax returns.  Block missed their real estate taxes, auto excise and self-employed health insurance deductions resulting in them overpaying their tax by $8,600.  When they had Block amend the returns (for a fee) the Block person actually had the audacity to say “I love it when we can save you tax dollars.”

·         A UK citizen but US resident has been living in the US since 2012 and has bank accounts back in the UK.  He had been using H&R Block from 2012 – 2014.  Well, the United States has this little filing called FBAR (Foreign Bank Account Reporting) where US tax filers need to report all foreign bank accounts with balances greater than $10,000.  The penalty for non-compliance is $10,000 for EACH account.  Thanks Block.  You left my new client with $30,000 worth of potential penalties by not knowing this rule.  It may be possible to fix this but the exposure is still there and it is going to cost my client $$$ to have me try. 

·         I met with a prospect that had used Block to prepare their S Corp. returns (huge mistake).  Block incorrectly recorded their balance sheet (not even needed on return) causing possible basis issues for the shareholders.  The return was just wrong! 

So Block, I'll answer the questions in your YouTube video:

·         At my firm a CPA with 20+ years of experience will actually prepare your return. 
·         You can sit with us at any time. 
·         We don’t use paper.  We do everything electronically when possible.
·         We have gone through numerous IRS and state audits and stand behind our work.  Of course, there are additional fees associated here.  When a Block employee represents you they are really there for the company CYA and not your benefit. 

Most Block employees have taken a 10-week tax class and are corporate franchisees.  Debi and I are both CPA’s, have degrees in accounting (I have a Master Degree in Taxation from Northeastern) and have been doing tax work for 20+ years. 

Oh, I have also seen Block’s pricing and most times, we are less expensive. 

Why pay more to have them file incorrect tax returns?

You make the call. 

Act like a Business

OK, so you have set up a corporation or LLC to limit your liability.  You want to protect your personal assets from business debts.  Now what?  There is more to running a LLC and corporation than just filing your annual report and corporate tax returns.  Sometimes courts will hold an LLC or corporation's owners, members, or shareholders personally liable for business debts.  When this happens it's called "piercing the corporate veil” and it is ugly.  Now your house, car and retirement fund are all exposed to your corporate debts. 

You have to act like a business!!!  Courts might pierce the corporate veil and impose personal liability if there is no real separation between the company and its owners.  If the owners fail to maintain a formal legal separation between their business and their personal financial affairs, a court could find that the corporation or LLC is really just a sham and that the owners are personally operating the business as if the corporation or LLC didn't exist.  For instance, if the owner pays personal bills from the business checking account.  So, if you are doing this, it’s time to stop.  Your corporate credit card and bank account should only be used for business expenditures!

So, what do I do? you ask.  To stay out of trouble it's important for small corporations and LLCs to comply with the rules governing formation and maintenance of a business entity, including:

·         holding annual meetings of directors and shareholders or members

·         keeping accurate, detailed records (called "minutes") of important decisions

·         adopting company bylaws and making sure that officers and agents abide by those bylaws.

·         DO NOT comingle assets.  Your entity should maintain its own bank account and you should never use the company account for personal use or deposit checks payable to the company in a personal account.

·         Make sure the world knows it is dealing with a corporation or LLC by conspicuously identifying the company status ("Inc.", “PC” or "LLC") on all forms of company communication.  When signing company documents, clearly state your representative capacity (such as, "Jane Doe, President, Acme LLC.")

And, just in case you don’t like keeping business records, a decision on veil-piercing was handed down in 2014 by the Massachusetts Appellate Division, in Kosanovich v. 80 Worcester Street Associates, LLC.  The court pierced the veil of a single-member LLC based on only one factor: the LLC’s failure to maintain business records.

Tax Lessons from U2

I was listening to an old U2 song while working and think that it is fitting for this time of year. It goes something like this. “October and the trees are stripped bare of all they wear. What do I care?” (U2, October, 1981)

I really think that this song is about taxes and believe me, U2 cares!!! In 2006 the Irish government decided to limit tax free earnings on artistic royalties to €250,000 ($338K US). This would have caused a huge tax bill for the band so they decided to move some of their business to the Netherlands which is considered to be one of the most tax favorable countries in the world.

According to Billboard, U2’s 2009-2011 tour grossed around $736 million. It is estimated that the total net worth of the band is over $800 million. So, you can imagine their tax savings by leaving Ireland and its 12.5% tax on royalties for the Dutch tax rate of 5%.

U2 has received a lot of bad press for this move since critics believe that it is totally hypocritical to their human rights activism. I’ll let the philosophers debate the ethical issues. I can say that what they did is perfectly legal and the band still pays close to half of their income in various taxes.

It is October…Do you care? What’s the moral of this story? Good tax planning saves money! It doesn’t need to be complicated and you won’t have to go to Holland. Sometimes simply taking a look at your situation before the year is over can save you money.

Now is a great time to plan for the end of the year. If you would like to discuss your tax planning please call me.

Getting a Hug

This has never happened to me before but last week I met with two different clients that I had not seen in a few months.  I held my hand out to shake theirs and both clients gave me a hug.  Those who know me well also know that I am not a publicly affectionate person.  But I must say that both of these hugs made me feel very nice.  It was almost as though they were acknowledging the service that I provide.  I really enjoy working with my small business clients and consider building relationships as important as the work itself.  It is very rewarding when I can see the passion that my clients have for their business and know that my services are helping them to succeed. 

Bad news for firms that reimburse workers tax free for health insurance

Employers could owe a $100 per day penalty according to the IRS. 

The IRS just issued guidance on the tax treatment of employers who give tax-free money to their employees to help pay for insurance purchased through health insurance exchanges like the Mass. Health Connector.  These employers will be in violation of the Affordable Care Act (ACA) and subject to tax penalties that could be as much as $100 a day or $36,500 a year, per employee. This ruling effectively prevents employers from shifting costs to the government by “dumping” employees into the new health exchanges rather than providing workers with health coverage, as mandated by the ACA.

This new ruling eliminates many arrangements that employers have made in the past with workers to reimburse them for health insurance premiums and out-of-pocket costs. According to the IRS, when an employer reimburses employees for premiums, the arrangement, known as an employer payment plan, is subjected to taxes.

Right now, the IRS has not indicated how strict it will be in levying the penalty.  If the premium reimbursement is done on an after-tax basis, that arrangement generally is not subject to the excise tax. 

The federal government has already postponed until 2015 enforcement of the employer mandate, which requires employers with 50 or more full-time employees to provide insurance for full-time employees until 2015. Failure to comply carries a penalty of up to $3,000 per employee. The $100-a-day tax is separate from that fee, and will be assessed on employers who fail to provide plans that meet ACA standards.