Brian Borawski CPA, PC

Author Archive

When you’re starting a business, be careful what you do with your start up costs.  Costs that you think would normally be deductible may not be and this is all because of Code Section 195.  Start up costs fall into one of three categories…

1)  costs incurred in investigating the creation or acquisition of a business
2)  costs incurred in creating an active trade or business and
3)  any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of that activity becoming an active trade or business.

If your costs fall into one of these two categories, then the IRS gives you two choices.  You can fully capitalize the costs which means you get no deduction and the costs are rolled into the basis of your business.  Option two lets you amortize the costs over 15 years although there is a provision for costs incurred after 2004 that allows you to expense the first $5,000 in costs (although if you have more then $50,000 in costs, then the amount you expense is reduced dollar for dollar for the amount that exceeds $50,000.  Fifteen years is a long time so be sure to consult with a professional to make sure you’re classifying your costs correctly.

It looks like the IRS isn’t happy with the level of compliance with US citizens who go overseas to work.  They’ve offered a special deal to certain overseas taxpayers that would allow them to escape penalties if they file their back tax returns.  This also applies to Reports of Foreign Bank and Financial Accounts.  The returns that are safe-harbored in are those where tax due is $1,500 or less and it requires you file three years of tax returns and six years of Reports of Foreign Bank and Financial Accounts.

While we have a number of expiring tax provisions, we also have a few new ones.  This one is courtesy of the 2010 Health Care bill (Obamacare) and it puts into place a medicare tax on unearned income which starts 1/1/2013.  The tax rate is 3.8% and it’s on the lower of the persons’ net investment income or their modified adjusted gross income over a certain limit.  Investment income includes interest, dividends, capital gains, annuities, royalties, rents and pass through income like income from K-1’s from S-Corporations and partnerships.

The modified AGI limits are $250,000 for married filing jointly and qualified widows or widowers, $200,000 for head of household and single tax payers and $125,000 if you file married filing separately.  Finally, if you’re an employee and your salary is over those threshold amounts, you get hit with an additional medicare tax of 0.9% which brings it up to the tax on unearned income of 3.8%.

What’s interesting is they’re creeping into making S-Corporation income subject to payroll taxes.  You have to be over the threshold but once you’re over, it makes the difference between a salary and a distribution a little bit less enticing.

Did you start a business or form an entity and now you need an Employer Identification Number, or EIN? You can get your number online and it only takes a few minutes.

Enacted in 2011, employees and self-employed people alike received a temporary 2% cut in their payroll taxes.  Mired in Congress, the extension of this tax cut was given some odd treatment because the two sides of the aisle couldn’t agree on how to pay for it so for a while, there was just a two month extension.  At the end of February, a full year extension was finally passed but as we get closer to the end of the year, it’s unclear what the fate of this tax cut is going to be.

If you’re an employee (of a company you don’t own), there’s not a lot you can do to plan.  Either the cut will be extended and you’ll get or it won’t and you’ll see your pay check take a hair cut.  For the self-employed who pay SE tax, you fate is about the same.  If you’re an employee of your S-Corporation, there is a little bit you can do.  In December, if the political winds are telling you that an extension isn’t going to pass, it might be a good time to push some salary (maybe a one time bonus or an advance) from 2013 into 2012.  Other than that, this one is a big “wait and see.”

Buying a business presents a host of both tax challenges and tax options.   Knowing how you buy a business and how it’s going to be presented on a tax return can be just as important as the actual purchase price.  As usual, I’m going to talk about things in a general sense.  If you’re buying or selling a business, be sure to consult with a professional.

Alright, let’s start with the two types of sales.  There are asset sales and stock sales (stock being the shares of a company, if it’s an LLC, it’s not stock it’s partnership units).  An asset sale is where the assets of the company are sold where as a stock sale is where the stock or interest in the company is sold.  Usually, if you’re the purchaser, you want an asset sale.  If you’re the seller, usually a stock sale is the more beneficial.  The primary reason an asset sale is better for the buyer (talking strictly from a tax perspective) is that the difference between the value of the assets and the purchase price of the transaction is amortizable goodwill while under a stock sale, that difference isn’t an amortizable expense.  Of course a stock sale is usually an easier transaction administratively.

Let’s look at an example.  You decide to buy a tanning salon for $30,000.  It’s in a good location, it has below market rents for the next few years and the current owner has done a horrible job marketing the company so even though the assets of the company are only worth $20,000, you feel the $30,000 purchase price is a bargain based on the profit you’re going to bring in.  Both sides agree on the value of the assets and both sides fill out and agree on a $20,000 allocation to tanning equipment and $10,000 of goodwill on Form 8883 (Asset Allocation Statement).  Assuming you’re using a business structure, your business buys the “assets,” begins operating it and come tax time, the $20,000 in equipment is depreciated over a five or seven year life while the goodwill of $10,000 is amortized for tax purposes over 15 years.

Under a stock sale, let’s assume the tanning salon is owned by a company called Tanning Salon, Inc. and it’s taxed as a C-Corporation.  For the same reasons above, you decide to buy the company for $30,000.  The equipment has a value of $20,000 but it’s depreciable basis is $10,000 because the current owner has taken advantage of some of the more recent bonus depreciation provisions.  Your “outside” basis in the stock is $30,000 so if you ever sold the stock in the company, this is what you’d use to compute your gain on the sale.  Like in the asset sale example, you’d then start operating the business but now your depreciable value in the equipment is only $10,000 because you stepped into the shoes of the previous owner.  There’s no goodwill to amortize under this type of transaction.

The final example has the tanning salon being owned by Tanning Salon, LLC and there are two owners who own a 50% piece of the LLC each.  You’re buying out one of the 50% owners for $15,000 and you’re doing it by buying his interest in the LLC.  The depreciable basis of the assets is $10,000.  Since this company is a partnership for tax purposes and there’s a change in ownership of 50% or more, you’d have what’s called a technical termination.  Under a technical termination, the LLC would file a “final” tax return on the date of the purchase (usually a short period return unless the sale happened at the company’s year end) and then there would be a second short period return that would take place from the date of the sale to the LLC’s normal year end date.  In the “new” company, all of the depreciable assets would then restart.  So you’d have a “new” basis in the asset that consists of the “old” companies purchase price in the asset less any depreciation and you’d depreciate them as if they were just purchased.  This one can get messy so if you’re buying out an LLC member, like any of these situations, be sure you’re talking to an expert.

I really didn’t cover “everything” here (there’s entire books on the subject) so if you have a question on an issue I didn’t touch on, just leave me a comment and we can make this a living thread.

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.