Posted on September 20, 2015May 31, 2016 by Jan Roberg

Should Your LLC Be an S Corporation?

If your small business has reached the point where your self employment taxes are really hurting you, choosing an S Corporation status might be the answer to your problem.

If you own a single member LLC, the IRS considers that to be a “disregarded entity.” That basically means there’s no such thing as an LLC tax return. So, if you don’t make an “election” to taxed some other way, you’re taxed as a sole proprietor on your 1040 personal tax return. That means, you not only pay income tax on your LLC income, you also pay self employment tax on top of it. Ouch!

But as a disregarded entity, you may make an election to be taxed as an S corporation (or even a C corporation if you want to) instead of being a sole proprietor. So how do you know you might be ready to be an S Corp? Here’s my top three criteria:

1. Steady net income. If you have a loss on your business, that business loss can offset your other income on your tax return. One of the big benefits of an S corp is to reduce your self employment tax. If your business has a loss, you’re not paying self employment tax anyway so the S corp status wouldn’t provide much benefit there. A good rule of thumb, but certainly not a deal breaker, is to have a net income of about $50,000 to make the tax savings be greater than the additional cost of separate tax returns and payroll expenses. I work with business that have losses and still are S Corps. The $50K income isn’t a requirement, it’s just sort of a break even point on costs.

2. Separate Employer Identification Number (EIN) and bank account. If your business is set up as an LLC, you should have a separate EIN and a bank account for your business already. I’m always surprised by people who skip this step, but it’s important. You can get an EIN number for free, online. It takes about 5 minutes.

Learn more here.

And you really need a separate bank account. You don’t want to co-mingle your business funds with your personal money.

3. Discipline to make monthly payroll deposits and quarterly reporting. One of the requirements of an S Corporation is that the owner has to pay him or herself a reasonable wage. That means, even if nobody else works for you, you still need to write yourself a paycheck and pay yourself like an employee. If you’re already making your quarterly estimated tax payments–you’re probably able to handle doing a payroll. If you’re scrambling every year, you can’t keep on schedule etc, then I say don’t do the S corp. Not being up to date on your estimated payments can be a problem, but the IRS can get really nasty if you’re behind on payroll tax deposits.

If you have no discipline, and your business easily has enough revenue to handle the payments–and still want to do the S Corp, then pay the extra money to hire a payroll company to do it for you.

Setting a reasonable wage is usually the most difficult thing to determine. You want to go by what a person in your line of work would get normally get paid, that’s not always easy to figure. You should probably have your wage be at least 1/3 of your net income unless you can document that people in your line of work usually make less.

Now, these are just my guidelines. There’s really no “set in stone” criteria for S Corp status. And really, before you make any change to the status of your business, what you really should do is run the numbers. Sit down with your tax professional and – using the most recent tax return – run the business numbers as if you were an S Corp, a C Corp, and as a sole proprietor. Don’t forget to include the costs of your payroll taxes when running the numbers.

Everybody’s situation is a little different. Compare your numbers side by see to see if changing to an S Corporation makes sense for your small business. That’s really the best way to tell.

Posted on December 27, 2013May 31, 2016 by Jan Roberg

Getting a 1099MISC When You’re Not Self-Employed

If you receive a 1099MISC document in the mail, and there’s a dollar amount listed in box 7 for Non-employee compensation, the IRS treats that as self-employment income and you’re supposed to pay self-employment tax on that income. If you own your own business, that’s perfectly normal. By the way, I’ve got lots of blog posts and tax tips for self-employed folks on this web-site so be sure to check those out. I’ve got a list at the bottom.

But what if you’re not self employed? Really not self-employed. You’re stuck with a document that basically requires you to pay extra tax, what do you do?

First, only dollar amounts in box 7—count as non-employee compensation. If you received dollar amounts in box 1 for rents or box 3 “other income” you don’t have to worry about the extra self-employment tax. The rent goes on your Schedule E for rental income and the other goes on line 21 of your 1040.

But let’s get back to that non-employee compensation again. What did you do to earn that money? Is it in your field of work? If the answer is yes, then it’s going to count as self-employment income even if you don’t think of yourself as being self-employed.

I’m going to use my friend Rick as an example. He works for another tax company and he’s very good at what he does. Every year, Rick gets laid off on April 15th. My company stays open all year round and sometimes I’m super busy in September and October. I could probably use some extra help around then. If I hired Rick to help me with some tax returns, I’d give him a 1099MISC for the money I paid him and he’d have to report that as self employment income. Even though Rick normally works for another company, he’s still in the business of preparing taxes. The money I pay him for tax prep would definitely be considered self-employment income.

But let’s say I hire Rick to paint my office instead. Rick’s not a painter, he doesn’t do that as a business, he’s just helping me out because I need my office painted and I’m helping him out because he needs the money. We’re friends. Painting is not his line of work. So technically, he’s not self-employed and he shouldn’t have to pay self-employment tax on that income. It’s a one shot deal never to happen again. How do you account for that?

Well, it used to be that if you received a 1099MISC for non-employee compensation for under $1000 and you put that amount on line 21 of your 1040—the IRS would let that slide and not audit for self employment tax. But starting with 2013 tax returns, the IRS has announced that they will send notices to anyone with 1099MISC income (with non-employee compensation) on line 21 instead of putting it on a Schedule C—where it will be taxed with self-employment tax.

There’s no box to check or form to fill out with your 1040 to say, “Hey, I’m not self-employed! I shouldn’t have to pay self-employment tax!” So what do you do?

You’ve basically got two options:

One: Claim the income as business income and write off any and all expenses associated with the job. This is going to be the best choice for people who have expenses with a job like mileage or supplies.

Or, two: File your 1040, pay the self employment tax, and then file an amended return 1040X taking the income out of self employment and putting it on line 21 with the explanation that you are not self-employed and the income should not have been subject to self employment tax.

Why do this as an amendment instead of doing it that way the first time? Because the IRS has already announced that they are sending letters out to anyone who puts 1099MISC for non-employee compensation income on line 21. And they charge fines and penalties for underreporting your tax.

By filing and paying the self-employment tax first, then amending, you’re giving the IRS the opportunity to examine the situation and make a determination. You may win, you may lose. But if you win—the case is closed and they won’t come back at you. If you lose—it doesn’t matter. You already paid the tax and they can’t fault you. No harm, no foul.

Most people who receive a 1099MISC for non-employee compensation are going to be considered self-employed by IRS standards. You may as well file the schedule C with your tax return and pay the self-employment tax. If you think you might be an exception give us a call, we can help you sort out your options.

Posted on December 13, 2011May 31, 2016 by Jan Roberg

Tiny Business Owners: When You Don’t Want to Reduce Your Income for Tax Purposes

Photo by Derrick Coetzee on flickr.com

I know what you’re thinking: “Come again? You must be out of your head! Don’t I always want to reduce my income for tax purposes?” Sometimes, the answer is no. Actually, I got the idea for this post from Howard, one of my readers with an accounting background and an owner of a struggling restaurant.

I’m walking on a tight rope here so I want to make sure that I explain this carefully. Under tax law, a small business owner is required to report all of his income and expenses accurately. I’m always telling people “don’t make stuff up” – that’s my rule and I stand by it. That said, there’s some leeway, like prepaying expenses at the end of the year to reduce your business income and stuff like that.

Where I’m going with this is there are some people who don’t want to reduce their business income for the tax year. One category is people who are applying for a home loan—you want your net income to be as high as possible, even if you’re paying self-employment taxes because the bank will be looking at your net income. The other category of folks who might not want to reduce their business income is people who may qualify for an Earned Income Credit (EIC).

Since leaving the big box tax company, I haven’t filed a lot of EIC returns; most of my clients are small businesses owners and have incomes that are too high to qualify. But last year, I had 5 EIC returns for people who had never even heard of EIC before, basically small businesses that had hit a rough spot with this economy. (I do lots of returns for people who don’t own businesses too. But I’m on a business roll right now.)

So here’s the thing: as a small business owner, you’re taxed 13.3% for your self-employment tax for 2011. If you make a net profit of $10,000 your self-employment tax is about $1,330. (Not exactly, it’s a funky equation, but that’s pretty close.) If you’re single with no children, the Earned Income Credit would be about $278, so it would make sense for you to lower your net income if you can so that you reduced the self-employment tax. But, let’s say you’re filing as head of household with 2 children – in that case your Earned Income Credit would be around $4,010 so reducing your net might not be such a good idea.

Bottom line: the tax strategies for a business owner who is a parent may be different than the strategies of a business owner with no children.

The IRS website has an Earned Income Tax Credit Calculator to help you determine how much of an Earned Income Credit you can receive if you qualify for one. Here’s the website: http://apps.irs.gov/app/eitc2010/SetLanguage.do?lang=en.

Remember, that’s just the EIC and it is an estimate. Remember that for your-self employment income, there’s also self-employment tax – the quick and dirty calculation for that is 13.3%. It will help you figure out where you stand with the EIC compared to self-employment taxes.

If you’re married and your spouse has income, that income will be included in the overall calculations, so EIC may not be a factor for you.

There are so many things to think about when you own your own business. It’s a good idea to get some professional help at least once every three years to make sure you’re on track and getting every deduction and tax credit you deserve. If you have made mistakes in the past, a professional can amend your prior year returns and get you refunds for what you’ve missed as long as you’re within that three year time limit.

Posted on November 8, 2010December 17, 2016 by Jan Roberg

Small Business Basics

Deduct all of your legitimate business expenses

I’ve done a lot of posts about unusual small business deductions, but I haven’t done anything about the basics. If you’re new to the small business world, that’s what you really need to know. These are some of the basic, core facts that you need to know to prepare your small business taxes.

First, if you’re just starting out, and you haven’t filed any papers like articles of incorporation, and you don’t have any partners, then you’re considered to be a sole proprietor. Your business tax return goes on a form called a Schedule C, and that’s part of your regular 1040 form. Don’t file your personal taxes and then try to file your business return later, they’re one and the same thing.

What if I’m an LLC? An LLC is a limited liability company, it’s not a corporation. Most LLC’s will file as sole proprietors unless they have filed documents to be taxed as an S or C corporation. (Then they file corporated tax form 1120S or 1120.) LLCs that have partners will file partnership returns, form 1065. This post is about sole proprietors who file Schedule C with their 1040 return.

A popular question I hear is, “How much money do I have to make to file a return?” According to the IRS, if you make over $400 of self employment income, you are required to file a federal tax return. This is very different from the minimum filing requirements of regular returns. Once you’ve made over $400, that income is subject to self employment tax and the IRS is very keen on collecting your self employment tax.

Another common question is, “How will the IRS know that I’ve made over $400?” The easiest way for the IRS to find out your income, assuming that you haven’t reported it yourself, is from forms 1099MISC. Many companies hire people as contract labor and don’t withhold payroll taxes. If you make over $600 from them, they are required by law to give you a form 1099MISC, showing how much they paid you. A copy of that form also goes to the IRS. That’s the most common way small businesses can get in trouble for underreporting their income.

Another way the IRS can find out that you’re not reporting your income is through your bank records. Let’s say for example that all of your business transactions are for cash and you never receive a 1099MISC. Although you wouldn’t get caught as quickly, let’s say you had an annual income of $20,000 from your all cash business. Your spending would be out of line with your income and could trigger an audit. A quick look at your bank statements would prove you weren’t reporting your income. If you’re serious about starting a real business, do it right and have a plan for handling your taxes. It will save you a lot of trouble in the future.

Small business income, unlike wage income, has one big disadvantage–it get’s taxed twice. First, it’s taxed at your normal tax rate and then again at the self employment tax rate (15.3%.) Let’s say you’re already in the 25% tax bracket for another job you have, your self employment income would then be taxed at 40% (the 25% plus the 15%.)

Small business income also has one big advantage–you can reduce your self employment income by any expenses you had acquiring that income. You may even have more business expenses than you have income, in that case, you can use your business losses to reduce your regular income, that lowers your overall income tax bill. Now you don’t want your business to be losing money every year (that’s not really good business practice.) But when you’re starting up, being able to deduct your losses is very helpful.

So what kinds of expenses can you deduct? The key phrase that the IRS uses is anything that is “regular and necessary” for the business. A good guideline is right on the Schedule C form. Here’s a link to it right here: Schedule C. Advertising, legal and professional fees, auto expenses, insurance, rent, repairs and maintenance, supplies, and office expenses. Meals and entertainment are deducted at 50% of what you spend (since the idea is that you’d have to eat anyway.)

If this is your first time filing taxes for your small business. I recommend getting a professional to help you. Even if you have a knack for the paperwork, it really helps to have someone else go over the possibilities of what you can deduct and make sure that the big things like depreciation (if you have that) are handled correctly. If you get started on the right track, it’s easier to stay that way.