Small Business Links

Archive for the ‘Business Taxes’ Category

PostHeaderIcon Installment Sales

Selling an asset can be taxing and sometime you run into problems when you sell an asset and you don’t collect all of the money at once.  Let’s look at an extreme example.  You have a building that’s worth $1 million but you’ve owned it for so long that it’s fully depreciated so if you sell if for $1 million, you’re going to have quite the gain.  Since it’s a long term capital asset and you sell it by the end of this year, your gain would be 15%, or $150,000.  You had a hard time finding a buyer and the one you finally found is cash strapped and they put 10% down and you seller-finance the rest.  The problem here is, your tax ($150,000) is actually more then the cash you received ($100,000) so you’re left with a shortfall.

That’s where the installment sale rules come in.  You can elect to report your gain on an installment basis if you expect payments in a tax year after the year of sale.  This is done on Form 6252 and the first thing you need to do is compute the gross profit percentage. In our example, since there’s no longer any depreciable basis, the gross profit percentage is easy because it’s 100%.  That means whenever you collect principal payments, you pay tax on 100% of the amount received.  In our example, the down payment would result in a $100,000 or $15,000 in tax (assuming this year).  If you collected $50,000 in principal next year, that would be your gain in that year and so on until the note is paid off.

One interesting quirk this year is capital gains are expected to go up in 2013 so you might want to actually pay the tax on the entire amount rather than wait and potentially pay a higher tax rate in the future.  The good news is, you elect the installment method when you file your return so you could potentially put off the decision until you have a better handle on what tax rates will be.

PostHeaderIcon New Late S-Corporation Election Rules

S-Corporations are fairly popular and they can be a powerful tool in your tax strategy.  In order to qualify as an S-Corporation there are some requirements you have to meet and then you have to make the election.  The requirements include

1)  Being a domestic corporation
2)  Having shareholders that are only individuals, estates or trusts (or a disregarded entity like a single member LLC)
3) Having only citizens or US residents as shareholders?
4)  Having only one class of stock
5)  You can’t have more than 100 shareholders

From there, you have to make an S-Corporation election.  This must be made on or before the 15th day of the third month of its tax year in order to be timely.  So if you form a corporation and want it to immediately be treated as an S-Corporation, you have two and a half months after it’s formed for a timely election.  If you have an existing C-Corporation and you want it to now be treated as an S-Corporation, then you have two and a half months after its year end to get the election filed timely.

If you don’t make the election in time, you can “try” to make a late election.  I’ve done this before and I’ve never had a late election turned down, which makes the whole deadline thing seem moot but it requires a few attachments to your return and there would always be the chance that you’d get turned down.

Last week, the IRS issued Revenue Procedure 13-30 which now simplifies this late election process somewhat.  What you have to do doesn’t change but it includes the rules for late S-Corporation elections as well as late QSub elections and entity change classifications.  The revenue procedure is long but at the end of the procedure are some really handy flowcharts to help you navigate the waters.  The Revenue Procedure also combines a few different revenue procedures so it’s one stop shopping from here on out.  As always, I’d suggest you talk to a professional and preferably one who’s done a late S-Corporation election in the past.  If you’re interested in seeing how an S-Corporation might benefit you, I recommend this blog post I wrote earlier in the year on the subject.

PostHeaderIcon Buying or Selling a Business – Technical Terminations

A few months ago, I discussed the differences between a stock sale and an asset sale.  In one of the examples, I touch on technical terminations and this concept deserves it’s own post.  Let’s start with an example.

Two friends set up an LLC and buy a piece of real estate with each owning 50% of the LLC,  The company files partnership returns (Form 1065) for several years, buys several new pieces of real estate and ten years later, it holds an apartment building, a commercial property and ten single family residences.  One partner decides he wants to go in another direction so he finds a buyer for his 50% interest, the sale is made, the old partner computes his gain on the sale and the new partner just steps into the old partner’s shoes, right??


Code section708(b)(1) discusses two ways that a partnership terminates.  The first way is if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership.  So if the partnership isn’t doing anything, it no longer exists.  The other way that a partnership is terminated is if within a 12-month period there is a sale or exchange of 50 percent or more of the total interest in partnership capital and profits.  That means in our example, the partnership has terminated and this has been called a technical termination because the partnership really continues to operate.

What does this mean?  First off, the partnership will have to file two tax returns in that one calendar year (assuming one technical termination).  If in our example the sale of the partnership happened on June 30, then you have a short period return going through June 30 with all of the normal due dates and then a second tax return from July 1 through the end of the year.

Second, depreciation starts over.  If you have commercial property that you bought for $1 million and over 20 years it’s depreciated, when the technical termination happens, then the new partnership’s cost basis would be the old partnership’s net taxable value (in this case, around $500,000).  The bad news is, the useful life resets so you’d then begin depreciating that $500,000 over a “new” 39 years.

In short, if you’re selling a partnership interest, talk to someone who knows partnerships.  You could do some planning to avoid a technical termination although even if you do fall into one, you have to know what to do with the short period tax returns.

PostHeaderIcon Start Up Costs

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.

PostHeaderIcon Employer Indentification Number (EIN) Application

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.

PostHeaderIcon Buying a Business – Stock Sale Versus Asset Sale

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.

PostHeaderIcon S Corporation Versus the LLC – The Payroll Tax Play

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.

PostHeaderIcon Amending Form 1099-MISC

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.

PostHeaderIcon What is Form 1099-K?

You should be getting your tax forms in the mail if you haven’t already.  The deadline for most forms we’re used to is January 31 so there could be some stragglers but I’ve also heard that some people already had their forms last week.  One form you may not recognize is the new Form 1099-K. If you accept credit cards or do a lot of business via a company like paypal, the Form 1099-K may be in your future.

In the IRS’s ongoing effort to have everyone else do their job for them, merchant services and third party payment processors are required to issue Form 1099-K to those they service.  If you accept any amount via credit card or use a third party payment processor like Paypal (and you have more then $20,000 in revenue and there are more then 200 transactions), then you should be receiving your forms soon.  Both the Schedule C and Schedule E have been changed to accommodate these new forms so be sure if you’re doing your return yourself, that you put everything on the right line.  For more information, here’s what the IRS has to say about the new form.

PostHeaderIcon The New Form 1040, Schedule C

Last week we talked about Schedule E and this week it’s Schedule C.  Yes, Schedule C has some changes and they look a lot like the changes on the new Schedule E.

First up is Lines I and J.  This is the IRS’ trap to get more Form 1099 compliance.  Be very careful how you answer these questions because if you have a large amount of expenses like professional fees and repairs, you could be opening yourself up to a notice or having the IRS take a second look at your return.

Also new is line 1a.    This is to report income from the new Form 1099-K that reports merchant card and third party payments.  If you take credit cards or use paypal, look for your 1099-K and this is where you’ll report that income.

Also new is line 27b.  Right now it’s reserved for future use.  I’m not sure where they’re going with that one so if someone knows, feel free to leave a comment.

That’s it.  These are the first changes to these forms in a while and it gives a pretty good indication of what the IRS is on the lookout for.  Their budget is being cut so they’re looking to 1099 compliance to help them out and they’re at least making taxpayers think about the 1099 issue by answering the questions.