Are You Planning To Incorporate a Business! Why Not an S-Corporation?

When you are planning to start a company, one of the key considerations you will have to make is what type of business entity to form. There are so many options:

• Corporation
• LLC
• Partnership
• LP
• LLP, etc.

Then, within corporations there are different types as well:

• C corp
• S corp

Plus, each entity type comes with further differences from state to state. It can be overwhelming to wrap your head around it all. Many people are especially confused about the difference between a C corporation and S corporation.

An S corporation is a regular corporation that lets you enjoy the limited liability of a corporate shareholder but pay income taxes on the same basis as a sole proprietor or a partner.

Unlike a C-Corp, which is a more conventional type of corporation, an S-Corp is a “pass-through” entity, meaning that it does not pay any income taxes on the corporate level. Instead, it passes the income tax responsibility on to employees and shareholders who receive their income through the company.

In an S-Corp, however, the IRS requires owner-operators who have direct control over operations to allocate a reasonable salary to themselves instead of relying completely upon income through corporate ownership. As with other pass-through business owners, S-corporation owners face the similar marginal tax rates as individual wages earners. However, how much owners pay in taxes can differ based on how much they participate in the business. These businesses are only allowed to have 100 shareholders, their shareholders must be U.S. citizens.

All owners of S-corporations need to pay federal individual income taxes (top marginal rate of 39.6), state and local income taxes (from 0 percent to 13.3 percent).

No Self-Employment Tax for S-Corporation shareholders business’s profits

The big benefit of S- corp taxation is that S-corporation shareholders do not have to pay self-employment tax on their share of the business’s profits.

The big catch is that before there can be any profits, each owner who also works as an employee must be paid a “reasonable” amount of compensation (e.g., salary).

This salary will of course be subject to Social Security and Medicare taxes to be paid half by the employee and half by the corporation. As such, the savings from paying no self-employment tax on the profits only kick in once the S-corp is earning enough that there are still profits to be paid out after paying the mandatory “reasonable compensation.”

Restrictions on S Corporations

There are a few key restrictions on S corporations as well.

For one, an S corporation may not have more than 100 shareholders, and all shareholders must be US citizens or US residents. There are no such shareholder restrictions for a C corporation.

Furthermore, C corporations are allowed to divide up voting rights by issuing different classes of stock.

S corporations are limited to one class of stock, giving all shareholders equal voting rights.

Finally, some types of businesses are not permitted to become S corporations. These include banks and some insurance companies, among other business types. C corporations are usually a better choice for large businesses with their sites set on an IPO due to their greater flexibility because an S corporation is restricted to not more than 100 shareholders.

Other Taxes

While paying yourself as an owner rather than as an employee reduces the employment taxes you must pay, income that you receive as the business owner is still subject to other taxes. As partial owners of an S-Corp, shareholders must report any income they receive on the IRS 1040 form K1, which makes this income subject to dividend or capital gains taxation.

Are You Aware That IRS Penalties Can Be Reduced?

Each year the IRS assesses millions of penalties against taxpayers. Most taxpayers are unaware that post-assessment the IRS also abates many of those same penalties. During fiscal year 2013 the IRS assessed 37 million penalties against taxpayers. The IRS later abated about 5 million of those penalties. Most of those abatements occurred because taxpayers or their representatives contested the penalties. It is important for those subject to IRS penalties to know their rights to dispute a penalty assessed by the IRS.

There are over 100 potential penalties that might be asserted against a taxpayer.

The majority of the penalties however: fall into two categories: collection penalties and accuracy related penalties.

The most common collection related penalties are:

• Late filing up to 25% of the unpaid taxes of the return
• Late payment up to 25% of the unpaid taxes
• Late federal tax deposits up to 15% of late deposits

The most common accuracy with related penalties are:

• Negligence penalty up to 20% of the understated taxes
• Substantial understatement penalty up to 20% of the understated taxes

For taxpayer subject to IRS penalties the IRS Penalty handbook provides a listing of the IRS’s favorite reasons for reducing penalties.

In considering non-assertion or abatement of penalties the IRS applies a standard of “Reasonable Cause”.

Most people are unaware that the IRS will consider the following as reasons it might reduce a penalty:

• Death, Serious Illness, or Unavoidable Absence
• Fire, Casualty, Natural Disaster, or Other Disturbance
• Unable to Obtain Records
• Mistake was Made
• Ignorance of the Law
• Forgetfulness
• Statutory Exceptions or Waivers
• Undue Hardship
• Written Advice From IRS
• Oral Advice From IRS
• Advice from a Tax Advisor
• Official Disaster Area
• IRS Error

The taxpayers who have not had a previous delinquency the IRS generally may apply a First Time Abatement Rule upon request by the taxpayer. If taxpayer has not previously been required to file a return or if no prior penalties (except the Estimated Tax Penalty) have been assessed on the same against the same taxpayer. This First-Time Abate (FTA) is an Administrative Waiver. A taxpayer seeking an FTA must request a penalty reduction in writing.

IRS employees reviewing penalties use a computer program known as reasonable cause assistant. In other words the IRS uses artificial intelligence to determine whether to reduce a penalty. Those who specifically reference to a section of the penalty handbook are much more likely to have IRS penalties reduced.

Not all IRS employees are adequately trained in the reasons for reasonable cause.

Those taxpayers referencing the penalty handbook have a much greater chance of success than those who merely submit a statement of facts to support their request for reduced penalties. In other words those who avoid the need for an IRS employee to research reasons for penalty reduction by citing directly to the IRS manual will be much more successful than those who rely upon the IRS to properly research that manual.

To qualify for penalty abatement you must convince the IRS that you should not be held liable for this additional money. Some examples of such reasons that will give you a good chance of receiving penalty abatement include: a serious sickness; a family problem, such as a divorce; the destruction of important tax records; hiring a tax professional who gave you harmful advice; a natural disaster; or long term unemployment. If you have faced any of these issues, you have a higher chance of getting your IRS penalties removed.

Income Tax Accounting for Trusts and Estates Tax Filing

Estates and non-grantor trusts must file income tax returns just as individuals do, but with some important differences. For one, their income is taxed at either the entity or beneficiary level depending on whether it is allocated to principal or allocated to distributable income, and whether it is distributed to the beneficiaries. Income tax accounting for trusts and estates has received relatively little attention from tax professionals as well as lawmakers. This is not surprising because of the comparatively few taxpayers affected. In addition, income taxation of estates and trusts does not generate much public interest—unlike the estate and gift tax, As a consequence, practitioners and their clients may not be aware of several tax issues related to estates and trusts. Careful planning that takes these issues into account is no less important than for other types of returns and can reap significant tax benefits. While trusts exist in many forms, this article principally concerns the most commonly encountered type of non-grantor trust. Other trusts that may be of interest to practitioners include those often used in conjunction with a small business, principally electing small business trusts (ESBTs) and qualified subchapter S trusts (QSSTs).

FIDUCIARY ACCOUNTING AND INCOME TAXES

Income of estates and non-grantor trusts is taxed at either the entity or the beneficiary level, depending on the answer to the following two questions.

1. Is each income, loss or deduction item part of the trust’s or estate’s distributable income, or is it part of a change in the principal?
2. Is the income, loss or deduction item distributed to the beneficiaries, or does the entity retain it?

Fiduciary accounting has been characterized as somewhat similar to governmental accounting because it deals with a fund (the trust principal) and income derived from the fund. The estate’s or trust’s taxable income is computed using the following formula:

Note: Trusts will reach the top marginal tax rate faster than individuals because of the depressed progressive tax schedule. Distribution deduction. To prevent double taxation on their income, estates and trusts are allowed to deduct the lesser of distributable net income (DNI) or the sum of the trust income required to be distributed and other amounts “properly paid or credited or required to be distributed” to the beneficiaries.  DNI is calculated based on accounting income less any tax-exempt income net of allocable expenses. The accounting method and period of the estate or trust determine when the deduction may be claimed; the beneficiary’s tax year is not relevant. Note: Because the tax rates of estates and trusts are likely higher than the tax rates of the individual beneficiaries, it is advisable (if possible) to retain the tax-exempt income and distribute taxable income only. The tax calculation for estates and trusts with regard to long-term capital gains rates is the same as for individuals. Thus, just as for individuals, long-term capital gains and qualified dividends are currently taxed at 15% and, for trusts and estates in the 15% tax bracket.

DIFFERENT INCOME TYPES AT THE BENEFICIARY LEVEL

The character of the trust income at the beneficiary level is determined based on the actual distribution amount and DNI unless the trust instrument or state law specifies otherwise. Direct expenses must be allocated to the respective incomes (for example, rental expenses must be deducted from rental income). Indirect expenses, such as trustee fees, must be allocated between taxable and tax-free income.

NEW LAWS AFFECTING ESTATES AND TRUSTS

The recently enacted health care legislation affects not only individuals and businesses but also the income of trusts and estates, Trusts and estates will be subject in 2013 and subsequent tax years to a 3.8% “unearned income Medicare contribution” tax on the lower of their undistributed net investment income or the amount by which their adjusted gross income (AGI) exceeds the amount where the highest tax bracket begins. Note: Since the threshold for individuals is much higher than for estates and trusts (and since most, if not all, trust income will be considered investment income), taxpayers may want to distribute more (or all) of the trust income to limit the amount subject to the 3.8% extra tax. Note that certain trusts will not be subject to this additional tax. Furthermore, simple trusts and grantor trusts are also likely to be exempt. A simple trust must distribute all current income; thus all income taxes apply at the beneficiary level, and it does not have any undistributed net investment income. A grantor trust is not considered a taxable entity because the grantor (or possibly some other person such as the beneficiary) is presumed to be the owner of the trust. The trust income is therefore taxed at the grantor level.

EXECUTIVE SUMMARY

• Income taxation of estates and trusts may not receive the same attention as individual income taxes or estate taxes. This article describes some of the general income tax rules of these entities, such as the different rules for allocation of income and deduction items between principal and distributable income, between tax- exempt and taxable income, and between trusts/estates and beneficiaries.
• These allocations are prescribed either by the trust instrument, state law or the Internal Revenue Code. In some cases, taxpayers have flexibility. Generally, it is advisable to “push” the taxable income and the income taxed at higher rates to the beneficiary, because the tax rate schedule for trusts and estates is depressed, with the highest bracket.
• Pushing income to beneficiaries may become still more important if lower tax rates under the Economic Growth and Tax Relief Reconciliation Act.
• Also, since income from estates and trusts is mostly investment income, the new 3.8% unearned income Medicare contribution tax will apply to most, if not all, of the trust’s income falling in the highest tax bracket. Individuals are not subject to this tax until their modified AGI reaches $250,000 (married filing jointly and surviving spouses) or $200,000. Thus, distributing trust income to beneficiaries can lower the amount subject to this extra tax.

Small Business Corporations – Be Careful with Your Tax Deductions! Tax Filing

small business tax deductions ,It is learnt that IRS will soon shift its audit focus from Large Corporations (C-Corps) to Small Business Owners (S-Corps/Partnerships/Independent Contractors), especially Pass-Through Entities.  Pass-Through Entities are the entities in which the Entity does not pay any tax but the members of such entities will do pay tax on their Individual Returns.

The reason behind IRS drifting its focus to Pass-Through Entities is that IRS found that many of the business expenses incurred by these entities are of personal in nature which they falsely claim as Business Expenses on their Business Tax Return.

In order to have a hassle-free tax filing experience and ensure long-run tax creditability of your business, it is important that every Small Business Owner will try to adhere to the following guidelines suggested by our Tax Consultants:

Avoid Cash Payments

Do not mix Your Personal & Business Bank Accounts

Ensure Proper Record Keeping

Draw Reasonable Salary

Avoid Cash Payments

The chances of getting audited by IRS is higher if you do a lot of your business payments in Cash. It goes without saying that if you receive more of your business income/receipts in Cash, the chances of IRS attacks are almost higher. You should always try to use Checks/Cards to support your expenses or receipts and avoid using Cash, except for certain ordinary and necessary petty business expense.

Do not mix Your Personal & Business Bank Accounts

This is one of the most common mistakes made by a large number of small business owners. Keep your business expenses for business purpose and don’t use your personal bank account to pay for them. Having two separate checking accounts for both business and personal purposes is very important. You can have more than one checking account as well for your business purposes, but they should be used only for business purposes and not for personal purposes.

Ensure Proper Record Keeping

Have a clear track of your incomes and expenses. You can use at least an Excel Spread Sheet to track all your incomes and expenses, if your business is too small to use an accounting software like QuickBooks, Peach Tree, etc. for recording day-to-day incomes and expenses of your business. If you are a medium sized business, it is advisable that you have your accountant do all this work for you while you focus on your business. Having proper records will also save you in times of audits/notices from IRS, when the Tax Authorities would like to vouch the actual expenses claimed on your tax returns.

Draw Reasonable Salary

The IRS requires you to earn reasonable compensation for the type of work that you’re doing. As a guideline, the government suggests choosing an amount similar to what another business would pay someone to do what you do. Owners of Pass-Through Entities have come under increased scrutiny of the IRS over the past several years, as they usually prefer to take withdrawals rather than Salary to avoid paying the associated payroll taxes. One of the largest financial risks to entrepreneurs is penalties and interest for incorrect payroll-tax reporting. Deciding how much to pay yourself, and whether to take the money as a salary or as a draw, requires careful consideration. You may consider taking an Expert Opinion before your plan your Salary withdrawals.