Brian Borawski CPA, PC

Archive for May, 2012

Over the course of my career, the most frequent conversation I’ve had with prospects and clients alike deals with what entity they use should to operate their new or existing business.  This is going to be the subject of my first special report so if you haven’t subscribed yet, I highly recommend you do because it’ll be out in the next week or two.  For now though, what I’m going to touch on is probably one of the more interesting aspects of utilizing an S-Corporation over a limited liability company (LLC) and that’s the potential to save on payroll taxes.  I hate to use the word loophole because this specifically in the Code but it’s also something Congress has been trying to “fix” so be sure if you take advantage of this, you keep up to date on what is happening. There have been two attempts to slip “fixes” into other legislation but both times they’ve been knocked down.

What am I talking about?  If you operate under an LLC, the earnings from your business is subject to self-employment tax which in 2012 is 13.3% (this is set to go back up to 15.3% in 2013).  If you operate under an S-Corporation, you’re required to pay yourself a “reasonable” salary (we’ll get back to that) but the same earnings that were subject to self-employment tax by using an LLC aren’t there under an S-Corporation.  Of course, the amount you pay on your “reasonable” salary is subject to those same taxes so you lose any benefit on that amount.

So let’s look at an example.  Keeping it simple, your company makes $100,000 (net taxable income). Using an LLC, if you owned this business 100%, you’d have to pay income tax AND self-employment taxes on this amount.  Now say this same company is using an S-Corporation structure and your salary is $50,000.  Now you’re paying income and payroll taxes on the $50,000 salary but only income taxes on the remaining $50,000.  The net effect is about a $6-$7k tax savings.  Not too bad.

Now let’s get to the downside.  First off, you’d better be able to justify your “reasonable” salary.  If you’re the sole owner and the sole employee, there can be an argument that the entire $100,000 should be your salary.   This is where you want to document why you’re doing what you’re doing.  Maybe the average salary in your area is $50,000 and you’re using the rest of the money to reinvest in the business at a future point in time.  Be ready to justify the amount.  If you have employees, it gets easier to justify a less then 100% salary because then there’s aspects of the business that can more easily be considered a distribution on an investment (i.e. your business).

S-Corporations are also more administratively burdensome.  Since you’re on the payroll, you have deposits to make and quarterly as well as annual payroll filings.  That by itself can chew up some of that tax savings in either time or money.  You’ll also have to pay unemployment tax.  So in short, an LLC is easier, but if you operate under an S-Corporation and can justify a salary less then the full amount the company makes, there can be some tax savings there.

The IRS recently put out IR-2012-53 which is an expansion on their “Fresh Start” initiative that’s being billed as a way for financially disadvantaged people to clear up their tax problems.  This new announcement focuses on the financial analysis the IRS is going to use to determine whether people qualify for an offer in compromise.  Now, the IRS will only look at one year of future income for offers paid in five or fewer months and this is down from four years and they’ll look at two years of future income for offers paid in six to twenty four months and this is down from five years.  There’s also an expansion of the allowable living expenses allowance.

What does all of this mean?  It means that more people should qualify for offers in compromise and of those that do, the offers should come with lower numbers for taxes paid.  If you owe back taxes and you’re in a tough spot, I highly recommend you talk to a tax professional.  I wouldn’t necessarily go with someone who advertises on the radio but this is something where you might want to get an extra opinion on.

This came up recently so I figured it’d be worth a quick blog post.  Here in May, one of my clients realized he had given me an incorrect amount on a 1099-MISC.  In order to fix it, here’s the appropriate steps.

1)  Contact the person or business in question.  This is more of a courtesy but you want to let them know that the 1099-MISC is wrong and that you’re going to amend it.  If they filed their return, it means they’ll have to amend as well.  If they’re lucky enough in this case to have extended, then you can provide him with a fixed 1099-MISC.

2)  When you’re printing off the new 1099-MISC, you check the box at the top to indicate it’s corrected

3)  Prepare a new 1096 (don’t mark it in any way) for just the one 1099-MISC.

4)  Mail the corrected Form 1099-MISC along with the new 1096 to the Internal Revenue Service.

Nothing too exotic here.

With a new year we get new luxury automobile depreciation limits.  You have code section 280F to thank for this one and you can find the new limits in Revenue Procedure 2012-23.  For passenger auto’s, the 2012 limit is $11,160 if the bonus depreciation rules (168(k)) apply.  For trucks and vans, the limit is $11,360.  If the bonus depreciation rules do not apply, the limit for passenger cars is $3,160 and the limit for trucks and vans is $3,360.

Doing a cost segregation study could be a beneficial exercise for a company that owns real estate but the Tax Court recently dealt a blow to those looking at a cost segregation study on assets acquired in an asset acquisition.  While usually more beneficial to the purchaser because the goodwill is amortizable for tax purposes, one of the exercises of an asset purchase is Form 8594 which basically makes you pool the assets purchased into buckets based on their character.  The Form is then filed with both the seller’s and purchaser’s tax return.

Putting a little extra time into Form 8594 is even more important now because of the Peco Foods Tax Court Case.  What the tax court determined was that the allocation done on Form 8594 is binding and that you’re not allowed to subsequently do a cost segregation study on the assets that were purchased.  You’re not even allowed to elect a Change in Method of Accounting on Form 3115 to effectuate a change in the allocation so once the Form 8594 is done, you’re stuck.

The moral of the story is, take the extra time to get this allocation done and as much to your benefit as you can.  You can usually work with the seller to get a solid allocation done that helps both of you so put in the extra time either during the negotiations or once the sale is getting close to being finalized because the final allocation could have ramifications for years to come.