Welcome to our new monthly email newsletter. We were somewhat frustrated. Surprisingly, despite the popularity of the S Corporation, we have yet to find any practical newsletter that deals with the day to day issues that small business corporations owners encounter.
As an S Corporation owner you are not alone. S Corporations are the single most popular form of corporate entity in the United States. This year more than 70% of the 4.1 million tax returns filed in the United States will be S Corporation returns. 68% of those 4.1 million tax returns had problems. Our goal is solve those problems before IRS does. Thus our new to date unnamed S Corporation newsletter.
As a quick refresher, an S Corporation is not subject to corporate tax rates. "Generally, an S Corporation is exempt from federal income tax other than tax on certain capital gains and passive income," according to the Internal Revenue Service. Instead, an S Corporation passes-through profit (or net losses) to shareholders. The business profits are taxed at individual tax rates on each shareholder's Form 1040. The pass-through (sometimes called flow-through) nature of the income means that the corporation's profits are only taxed once– at the shareholder level. The IRS explains it this way: "On their tax returns, the S Corporation's shareholders include their share of the corporation's separately stated items of income.
S Corporations therefore avoid the so-called "double taxation" of dividends. S Corporations, like regular C Corporations, can decide to retain their net profits as operating capital. However, all profits are considered as-if they were distributed to shareholders. Thus an S Corporation shareholder might be taxed on income they never received. (Whereas a shareholder of C-corporation is taxed on dividends only when those dividends are actually paid out.)
The big benefit--and the one that people usually talk about--is the payroll tax savings.
To understand how this works, let me compare two alternatives: A sole proprietor making $90,000 a year and an S Corporation making $90,000 a year.
Of course, the taxes that a sole proprietor pays depends on his or her filing status, itemized deductions and family size, but typically such a person might pay about $12,000 in federal income taxes. The person might also pay another chunk in state income taxes.
In addition to these income taxes, the proprietor also pays a 15.3% self-employment tax on the $90,000 of business profits. Roughly, this self-employment tax (which is equivalent to Social security and Medicare tax) equals $13,000.
Things usually work differently for the S corporation, however. To make calculations easy, assume the S corporation is owned by a single shareholder. In this case, the S corporation must break the $90,000 of profit into two buckets: wages and the leftover (which is called a distributive share). If the wages equal $40,000 and the leftover distributive share equals $50,000, the business pays Social Security and Medicare taxes (equivalent to self-employment tax) equal to roughly $6,000.
In this case, even though the two businesses make the exact same amount of money, the S corporation pays roughly $7,000 less in tax each year.
As of today Congress has not acted on the so called tax extenders. There are more than 50 different tax provisions that have expired this year including the very popular section 179 accelerated depreciation of certain assets purchased during the year. The section 179 provision in previous tax years has allowed businesses to take the full depreciation deduction of an item that meets certain specifications – in many cases machinery and certain vehicles – in the current tax year, with a maximum deduction of $500,000 and a phase-out threshold of $2 million. That deduction level, however, has fallen to $25,000 with a $200,000 phase-out for 2014, and will remain that way unless Congress acts on the tax extenders package before the end of the year.
The IRS is warning Congress that decisions about renewing tax provisions that expired at the end of 2013 must be made by late November or next year's tax-filing season could be seriously disrupted. Hopefully Congress will act soon but we are not optimistic. Negotiations over extending a slew of expired tax breaks could take until the end of the current lame-duck session of Congress, according to the Hill.com.
It is our recommendation that if you are considering a major purchase of a section 179 asset do it. The overwhelming popularity of this deduction will most certainly insure its eventual passage. The rules require you to put the asset into service in order to qualify for the deduct. In many cases the section 179 deduction made the difference between owing tax and not owing tax for many clients. Since the law requires you to put the asset into service in order to qualify for the deduction, you don’t want to take a chance that the asset will not be delivered in time before the end of the year.
Each year we preach to our S Corporation clients about the importance of record keeping for their business. Consider this recent tax court case in which an attorney an an ophthalmologist who not only were sent to jail for not filing their income tax returns, after filing their tax returns failed to substantiate mileage, travel and other deductions. All the stars aligned. In our imaginary tax world these very smart people did some very stupid things. And we can learn some lessons.
Professional Couple Overstated Business Expenses and S Corporation Losses
A professional couple was not entitled to deductions resulting from overstating business expenses on their joint income tax return, professional and legal expenses claimed on Form 1040, Schedule C, Profit or Loss From Business, rather than as miscellaneous itemized deductions on Schedule A, Itemized Deductions, and S corporation losses claimed on Schedule E, Supplemental Income and Loss. The wife was a practicing attorney who operated her own legal practice, and the husband was an ophthalmologist who was the sole shareholder of an ophthalmology practice that was an S corporation. Prior to filing their joint tax returns for the tax years at issue, the couple was convicted of willful failure to file federal income tax returns for previous years. They each were sentenced to 12 months imprisonment, 12 months
supervised release and a fine of $20,000. The wife claimed deductions on Schedule C for car and truck expenses and travel expenses. For the car and truck expenses, she did not maintain a contemporaneous mileage log, and their accountant based the number of miles driven on discussions with her. The documentation that the couple offered to substantiate the number
of miles driven consisted of seven parking receipts, an equipment lease, a help wanted advertisement, a phone message slip, and a few other documents. The evidence did not show that the wife’s mileage expenses were equal to the amount claimed. Similarly, the couple did not substantiate the wife’s travel expenses that were claimed deductions on Schedule C.
Business losses attributed to the husband’s business and claimed on Schedule E of the couple’s tax return for one of the years at issue were overstated. As the sole shareholder of the S corporation, the losses deductible by the husband were limited to his basis in the corporation. The wife stated that two deposits made into the bank account for the husband’s business were loans, but the couple did not provide sufficient evidence to show that the deposits were loans. Consequently, the two deposits were not figured into the husband’s adjusted basis in the S corporation. B.G. Hall, TCM, ¶15,485 Excerpted from Wolters Kluwer S Corporation guide.
So what can we learn from this case. You have to keep adequate business records or face issues if the IRS comes calling. Parking receipts, an equipment lease, and a phone message slip do not meet the requirements. Now is a very good time to look at your recordkeeping. Our recommendation is taking a look at wave apps. It is easy. Fairly comprehensive. Working with your tax guy is easy, too. Just invite us as a Guest Collaborator and we can both see your data, securely, in real time. Perhaps the best part is the automatic download your bank account into your accounting records limiting the amount of data input you have to do. Advantages? It is free. It is intuitive. No need to change the way you are doing business today. We like wave accounting so much we became a Wave accounting pro advisor.
We are going to tackle the murky crazy world of auto expenses next month.
As the clock winds down on 2014, you should carefully examine their tax withholding/estimated tax payment situations. If you’re having an especially good year, and/or if the new surtaxes may apply to you – check the level of your Federal income tax withholding, in comparison to the amount of payments required to keep you out of underpayment penalty trouble. Recall that the use of estimated tax payments doesn’t provide the same flexibility as withholding. An individual who has underpaid an estimated tax installment generally cannot avoid the penalty by increasing one or more estimates for later periods. But income tax withheld is treated under the law as paid in equal amounts on each of the four installment dates – even in situations in which a large amount of “extra” tax is withheld late in the year. Source Nolo.com/taxes.
From our September 02, 2012 client newsletter:
It seems that every successful business out there had to deal with failure. It is how you react to it that makes a difference. I like to say failure equals success. Sitting at Firestone today, waiting for them to remove the nail that somehow managed to puncture our front right tire, I stumbled upon the August 2012 issue of INC.Magazine. The magazine’s cover story features 14 entrepreneurs who discuss their successes, their failures, and the lessons they learned along the way. Two were fired from the companies they formed. Another worked 20 years for his overnight success. Another silenced her critics with a $120 million payday. All of these company founders had one thing in common, the emotional roller coaster that is entrepreneurship. All had failures along the way to success.
Drum Cafe is a corporate motivation and training organization that seeks to “building teams, uniting companies and motivating staff” through... I am not kidding you but it seems to work in Silicon Valley... interactive rhythmic drumming writes in their blog:
Every mistake is an opportunity to learn. What separates the forever failures from a rising phoenix success story is quite simply our willingness to observe a mistake and learn from it. Complete self honesty is absolutely imperative to this process. We also have to be willing to have a positive mind story. Here too the aspect of honesty is the truth that will set us free. If we are tapping into some sob story from our past that we have painted negatively, we cannot move forward. However, we can take that same story and ask ourselves “what did I learn from that experience?” There is ALWAYS something to learn. For example, if you walk down the street, paying no attention to the pavement below, you might trip over something. You can either decide to never walk in that area again, potentially missing something spectacular, or you can recognize you tripped because you were not paying attention. You learn to pay attention and walk down that same stretch of pavement and because of actually looking down you find a $100 bill!
Now that’s a simplified example, but I think you catch the point. In case you need a little more food for thought on the matter of failure being a stepping stone towards success, here are few noted success after failure stories:
R. H. Macy: We are all familiar with this large department store chain, but Macy didn’t always have it easy. Macy started seven failed business before finally hitting big with his store in New York City.
Harland David Sanders: Also known as Colonel Sanders of Kentucky Fried Chicken. The Colonel had his famous secret chicken recipe rejected 1,009 times before a restaurant accepted it.
Albert Einstein: Most of us think of Einstein as a genius, but did you know he did not speak until he was four and did not read until he was seven, causing his teachers and parents to think he was mentally handicapped, slow and anti-social? Eventually, he was expelled from school and was refused admittance to the Zurich Polytechnic School. He proved everyone wrong and in the end, won a Nobel Prize and changed the face of modern physics.
Stephen King: The first book by this author, the iconic thriller Carrie, received 30 rejections, finally causing King to give up and throw it in the trash. His wife fished it out and encouraged him to resubmit it. King is now one of the best-selling authors of all time.
Oprah Winfrey: Oprah faced a hard road to get to where she is today, enduring a rough and abusive childhood as well as numerous career setbacks including being fired from her job as a television reporter because she was “unfit for TV.”
Thomas Edison: In his early years, teachers told Edison he was “too stupid to learn anything.” He was fired from his first two jobs for not being productive enough. Even as an inventor, Edison made 10,000 unsuccessful attempts at inventing the lightbulb. Of course, all those unsuccessful attempts finally resulted in the design that worked.
I came home later today opening my email account to find this discussion about the Home Depot founders from Dan Kennedy, selling his $97.00 “Turning Adversity to Opportunity” DVD:
For example in 1978, Bernie Marcus and Arthur Blank were fired from their executive jobs at Handy Dan Home Improvement Centers during a corporate takeover. Instead of putting their tails between their legs, hiding out and going into paralysis mode like many would, they made a plan to create their vision--a chain of home improvement centers larger than any of the competition.
They named it Home Depot.
Although their grand opening was less than spectacular, I don't have to tell you that it wasn't long before the company exploded with growth and in only two decades became the
world's largest home-improvement retailer.
What does this all mean? First I believe, and most of conversations with fellow clients concur, the marketplace is not going to get any easier any time soon. Secondly I’ve actually seen conflicting numbers as it relates to exactly how many attempts Thomas Edison had at creating the light bulb. But they were all in the thousands. So, seriously, the next time you feel like quitting after failing, just think about the 9,999 failures he had. He never gave up and learned from each and every mistake. In fact, just before finally reaching success, Thomas Edison was interviewed by a young reporter who boldly asked Mr. Edison if he felt like a failure and if he thought he should just give up by now. Perplexed, Edison replied, “Young man, why would I feel like a failure? And why would I ever give up? I now know definitively over 9,000 ways that an electric light bulb will not work. Success is almost in my grasp.”
Do you know someone who having tax issues? We can help. According to IRS one in six taxpayers will have some sort of tax liability problem at some point. Along with my colleague, former Illinois Department of Revenue attorney Jim Chipman, we have helped dozens of clients solve their tax problems, and this is very important, honestly and affordably. If you know someone who is having problems, please ask them to call us.
Do you know someone who would like a copy of this email newsletter? If so pass it on or ask them to send us their email at taxpartnerfreereports@gmail.com.
Donald C. Fuener E.A.
President
November 19, 2014
Tax Partner Holdings Inc.
“the small business accountants”
2060 W Monroe
Springfield IL 62704
217-241-4597
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