I’ve gotten this question a couple of time recently so I decided to post about it. Here’s the question:
“My Dad died and my sisters and I want to keep the house and rent it out instead of selling. How do we handle the taxes on this?”
First, you need to change over the house to your names. That’s important. Get the house out of the estate before your rent it. Also, some day you might sell or something; you want to fix that now.
Now—you and your siblings are going to become a partnership. I recommend becoming an LLC—that means Limited Liability Company. It gives you a little protection in case someone you rent to decides to sue you. Here in Missouri, it only costs $50 to file online. Do file in whatever state you actually live in though—don’t do one of those “file in Nevada” things you see online—big mistake, unless you actually live in Nevada. File your LLC in the state you live in (or the state the house is in if that‘s different.)
After you file for your LLC, you will want to get an EIN number. Here’s information on that: http://robergtaxsolutions.com/2010/11/how-to-get-an-ein-number-for-your-business-for-free/ . Because you have a partnership, you’ll need the EIN number to file a tax return.
You will also want to have a separate bank account for the partnership. You’ll use the EIN number to set up that bank account. It’s important to do that. If you use your personal bank account for the LLC then you have (legalese here) “pierced the veil” of the LLC. That means if there was an issue, then you could be sued personally—so the bank account is important.
Okay, so now you’ve got the LLC, the EIN, and the bank account. You rent out the house, the tenant writes checks to the partnership, and the partnership pays bills out of the bank account—all good. If you have a profit, the partnership can make distribution payments to you and your sisters (the partners.)
At tax time you will file a partnership return, Form 1065. They’re due to the IRS by April 15th, but really they need to be done before then because you need that information to file your personal return.
The partnership will issue a K-1, tax form to each of the partners. The K-1 form is how you report the partnership income on your personal return so that you can pay your share of the taxes. Let’s say the house had a profit of $5001. The three of you are equal partners, so you’d each get a K1 saying that you had a profit of $1,667 that you would report on your personal tax return. Or if there was a loss, you’d report the loss which would offset your other income.)
As long as you and your siblings all agree, you should be okay. You might want to sit down together and write out some stuff like, what happens if one of the partners wants out? Who’s going to run the rental (collecting rent, making sure house is okay and stuff). Does the person managing that get paid something extra?
You are not required to have an attorney write up a partnership agreement. (You might want one, but it’s not required.) But do think through potential problems and decide how to solve them before you start. Example: what happens if one of the siblings falls on difficult financial times and needs to sell her share of the house? How will you handle that? A partnership is kind of like a wedding. It’s easier to get into than to get out of. Planning ahead will make those transitions easier.
Tiny business owners, you know who you are: you’re a single member LLC or sole proprietor, or maybe you’re in business with your spouse. You might even have an employee or two, but that’s about it. When Congress passes laws to help “small business” they don’t mean us. This post is for you. If you are a Sub-chapter S corporation, I’ve got tips here: http://robergtaxsolutions.com/2011/12/2011-year-end-tax-tips-for-your-single-owner-sub-chapter-s-corporation/
Number 1: If you’re going to be in the red for this year, you don’t really need to worry about reducing your business tax, right? Your negative business income will help offset your other income (if you’re lucky enough to have some). You can devote your energy to being profitable next year.
Number 2: If your business is in the black, congratulations! You’re going to want to look at cash flow and make sure you’re got enough cash to pay your upcoming expenses (like payroll and payroll tax if you’ve got it), but let’s look at some ways to reduce your excess income before the year is out.
Hire your kids: If you’ve got kids under the age of 18, you can hire then without having to pay FICA. It used to be if you had an LLC, you paid FICA for your kids but that changed in 2011 so even if you have an LLC, you don’t pay FICA on your children’s wages. There are rules that have to be followed, but if you could use a little help at work this time of year you’d at least be keeping the money in the family. For more information check this: http://robergtaxsolutions.com/2010/12/last-minute-tax-tip-hire-your-kids/
Pre-pay business expenses: Most tiny business owners use something called “cash basis accounting”, basically, you’re taxed on what comes in versus what goes out. If you are cash heavy, you can pre-pay some of your business expenses for up to twelve months. For example: I lease my office space, I’ve got a one year contract so I know that I’m going to have that monthly expense for the rest of the year. If I were cash heavy (in my dreams) I could prepay my rent for the entire 2012 year and write it off on my 2011 taxes. But you see how you can play with that? While I won’t be paying a full year of rent in advance, I did pay a few January bills early.
Delay invoices: Remember, this only works if you’re cash flush. Let’s say you did a job and a client owes you $1000 and you normally would send out the bill with a due date of December 30th. Change to due date to January 15th—you’re pushing that income ahead to next year. Besides, your client might just appreciate the break at Christmastime. I set up a billing schedule for a client that didn’t start until January and I used “I thought you could use a little Christmas break.” She was thrilled and I delayed the income—talk about a perfect win/win situation.
Credit card purchases: According to IRS rules, if you buy something with a credit card, you’ve bought it now. So, let’s say you’re a little cash poor right now but you’ll have the revenues next month to cover your expenses. Pay expenses with your credit card and it will count as having been paid when charged. I always like to be cautious about credit card spending–hate those bills, but it’s a good solution for some businesses.
This one I don’t like to say, but buy equipment: If you need it. I almost hate to list this as advice because it’s the standard that everybody says every year. One of my clients fired his old accountant for saying it. Like he said, “I know what I do need and don’t need to run my business and I don’t need any more equipment. What other ideas you got?” In this same category is the buy a new SUV that weighs over 6,000 pounds so you can use 100% bonus depreciation to write off the whole thing. Here’s my advice, “Don’t buy crap you don’t need.” If you do need equipment, and you’re profit heavy, it’s better to buy in December than in January. But buy what makes sense for the business.
Get your retirement plan in place: If you’re just investing in an IRA, you don’t need to worry about that yet, you’ve got until April. If you’ve been wanting to set up a SEP or a 401(k), you need to get that done by December 31st. Contact your financial advisor about setting up your retirement plan.
Last, because this isn’t really business: charitable contributions. If you’re a sole proprietor, your charitable contributions do not count as business expenses. So if you give money to the Salvation Army, that’s a personal deduction, not a business deduction. Every year, I see a lot of people trying to claim their charitable contributions as business expenses and it won’t fly with the IRS. Even if you pay a charity from your business bank account, it’s not allowed as a business expense. Charitable contributions won’t help reduce your self-employment taxes. Please give to charities and give generously, but know that it’s a personal deduction, not a business one.
Filed under: Self Employed, Small Business, Tax Deductions, Tax Preparation
If you’ve started a new business and you filed the Articles of Organization in your state to become an LLC, then here are some things you need to know about filing taxes for your new company.
First, there is no such thing as an LLC tax return. I know that sounds crazy, but it’s true. Every year, thousands of people walk into their accountants’ offices and say, “I want to file an LLC tax return!” This is what accountants joke about at their conventions and at the water cooler. We even post silly You Tube videos about it. This post is to help you not be the butt of some dumb accounting joke.
An LLC is a Limited Liability Company. One of the most common mistakes people make is that they think LLC means “Corporation”, it doesn’t. If you have an LLC, you probably are not going to file a corporation return (although you might, I’ll discuss that later).
The IRS considers an LLC to be something they call a “disregarded entity.” That means that it doesn’t have a specific tax document that goes with it. If your LLC only has one “member” (member is LLC-speak for owner) then the default tax return for your LLC is a Schedule C which is part of your 1040 income tax return. It’s due on April 15th just like any other individual tax return.
If your LLC has two or more members, then by default you are considered to be a partnership and you must file a partnership return, form 1065. Form 1065 is due on April 15th also, but it’s a good idea to get it done sooner because the information on the 1065 needs to go onto your personal tax return before you file it. When your accountant prepares the 1065, she’ll also prepare a K-1 form that will be used to prepare your personal income tax return.
So, if you have an LLC, the default tax return you might file would be a Schedule C as part of your individual income tax return, or a 1065 partnership return (and you’d receive a K1 form so you could put your partnership income on your personal tax return).
Instead of using the default filing options, you can choose to have your LLC treated as an S corporation or a C corporation for income tax purposes. It’s very rare to choose to have your LLC treated as a C corporation. Usually, if a person wanted to pay corporation tax rates, she would file articles of incorporation to begin with. But one advantage to filing as an LLC and then electing to be taxed as a C corporation would be to avoid some of the stringent reporting and meeting requirements that C corporations have. Usually, it’s not advantageous tax-wise to be treated as a C-Corporation, but there are always some exceptions. If you do go this route, you will need to file an election to be taxed as a corporation: form 8832. The tax return for a C-Corporation is called an 1120. You must file the 1120 or the extension by March 15th or you will be assessed a late filing penalty even if you owe no tax. A C-Corporation pays taxes on its income and pays wages and/or dividends to the owner.
The more common corporate tax treatment for LLCs is to be taxed as an S Corporation. A Sub-chapter S corporation passes its profits through to the owner. If you elect to be a Sub S Corporation, you must pay yourself a wage. For most businesses, the purpose behind a Sub-chapter S corporation is to avoid paying self-employment taxes. There are two things you must know:
1. A Sub S Corporation isn’t always the best way to avoid paying self-employment taxes and,
2. You’re not allowed to say that you’re trying to avoid paying self-employment taxes, even though that’s pretty much the reason anybody ever makes the Sub S election.
To make the election to be taxed as a Sub S Corporation, you will need to file form 2553. A Sub S Corporation tax return is called an 1120S form and it is due by March 15th. The S corp does not pay income tax; the income from the S corp will be reported on a K1 and will flow through to your personal tax return.
If you make an election to be taxed as a C or an S Corp, you will have to keep that designation for at least five years unless you get special permission from the IRS to change. You want to make sure you really want to make the election for corporate tax treatment before filing those forms.
Here’s my really important tax advice: Assume that you’re filing your LLC return either as a Schedule C (sole proprietor) if you’re a solo owner, or a 1065 partnership return if you have more than one owner, at least for the first year. But then, sit down with your preparer and run the numbers all three ways, (Schedule C, S-Corp, C-Corp) to see what makes the most sense for your business. Make some projections about your future income and expenses and take into account the deductions that you may have missed last year but won’t miss again. Smart planning can save you thousands of dollars in taxes over the years to come. Saving on taxes helps your business grow and puts money in your pocket.