20 Year-Round Tax Tips for Businesses

Among many challenges faced by business owners, tax compliance is one of the most significant one. Here are the important tax tips that you don’t want to miss out.

By BALJEET SINGH

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Being a business owner is a great thing; however it comes with many responsibilities and challenges. Tax compliance is one of the main challenges that business owners have to face. It is significant to know that tax compliance or planning is not limited to once in a year meetings with your tax accountant, year-end tax planning or filing annual income tax returns. All business transactions should be analyzed from a tax prospective on an ongoing basis. Here are a few year-round tax tips for business owners that could help them to comply with tax laws and save on taxes, potential interest and penalties.

  •  When you start a new business, consider different choices of business structures like sole proprietorships, LLC, C-corporation, S corporation etc. Choose the one that is more tax efficient and is best suited to your other business objectives. There are numerous factors that should be considered while making a choice of entity that you should review with your CPA. Once set up, keep reviewing the business structure on an ongoing basis and make the appropriate change if some different business structure is considered to be more tax favorable due to change in circumstances, your business objectives etc.
  • Give a careful consideration to the state where you would like your business to be incorporated. There are various factors that should be considered while making this decision. Some of the significant factors, that vary from state to state, include income taxes, sales taxes, franchise taxes, tax filing fees, business friendly laws and statutes. Of course, if some specific state otherwise makes more sense for you from a business prospective, you should go for that state.
  • Know the state income tax compliance requirements of any state where you carry out or intend to carry out business activities. Though the rules vary from state to state but in general, you need to register your business with a state and comply with tax filing requirements if you carry out major economic activity, generate revenue, have employees, rent or own office or property in the State. Be sure to get this evaluated before you indulge in business activities in any particular state and if required, get the registration done, obtain certificate of authority and comply with tax filing requirements.
  • Know the sales tax rules of the state where you carry out or intend to conduct business. The sales tax rules vary from state to state. Generally the sales tax is imposed on products, however many states now have sales tax on software services. Currently, there are many states that already require the sales tax on software services are Connecticut, Hawaii, Mississippi, Nebraska, New Mexico, South Dakota, South Carolina, Tennessee, West Virginia, Wyoming and Massachusetts.
  • Be aware of recordkeeping requirements by law. Have good systems in place to maintain books of accounts, supporting documentary evidences and additional details in a diary or log book or some other way. Maintain records for sufficient number of years generally for at least the period covered by the statute of limitation which is 3 years after the due date of the tax return or 2 years after the date the tax was paid whichever is later. (also read “Tax Records That Businesses Must Maintain” at https://baljeetsinghcpa.wordpress.com/2014/01/07/tax-records-that-businesses-must-maintain/)
  • Always keep separate bank accounts, credit cards, and other documents to keep track of business expenses separately.
  • Know the difference between employees and independent contractors, and classify them correctly. If an employee is wrongly classified as a contractor and IRS learns about the incorrect classification, it could result in back payroll taxes and penalties.
  • If any payment is made to stockholders/owners, be sure to classify it correctly as payroll or management fee or distribution depending on various factors like what role the stockholder is playing in the business? Are there other officers who are performing the actual operation of the corporation for which it was started? If an amount paid to the stockholder that is wrongly classified as a management fee instead of payroll, it could result in back payroll taxes and penalties.
  • Before an amount is distributed to an S-corporation stockholder, be sure that the stockholder is otherwise compensated by way of a payroll for services performed for the S-Corporation. If the stockholder is not sufficiently compensated for the services performed, then IRS could take a stand that distribution is made to stockholder instead of payroll as an attempt to avoid payroll taxes and could impose penalties on S-Corporation.
  • If a business give or take loans from shareholders, be sure to have a formal agreement to include the interest terms, repayment terms. If business financials reflect loan to or from stockholder, there should be corresponding interest income or expenses in the business’ financials and hence on the tax returns.
  • Be aware of requirements of issuing form 1099. Broadly form 1099 should be issued if any payment exceeding $600 is made during the course of your business to contractors either individual or partnership; payment of professional fee to an attorney, doctor, or other professional; payment to an individual or partnership, for rent for office space, machines, equipment. Payments include commissions, fees, interest, rents, royalties, annuities and any other type of compensation or income to a single recipient. Please note that form 1099 is required to be issued for payments to corporations only if they are for medical, health care, legal or fishing activities. Individuals are not required to send 1099-MISC for personal payments.
  • Be sure to timely deposit payroll taxes withheld from employee’s payroll. Do no use the taxes so withheld for the purposes of business operations. Using the payroll taxes for the purposes of business operation could attract criminal and civil penalties, and fines.
  • If you/your CPA decide to claim home office deduction on your income tax returns, be sure that the office must be used regularly and exclusively for conducting business. Further you can claim expenses including real estate taxes, mortgage interest, utilities and insurance for the portion the home is used for business.
  • If you receive some insurance proceeds for some causality loss, reduce the amount of causality loss by the insurance proceed before claiming the deduction for the same on the income tax return.
  • Be aware of passive loss limitation rules if you are an owner of pass through entities (e.g. S-Corporation, partnership etc.) and have losses in business. To deduct the losses, you should have sufficient level of participation in the business and should have sufficient records to evidence the participation. Also know the basis rules if you are an owner of pass through entity. The owners can deduct the losses to the extent of their basis in the business.
  • If you are considering issuing stock options, stock appreciation rights or other instruments to employees; you must consider getting a 409A valuation done to arrive at fair market price of the common stock of the corporation. Under Section 409A of Internal Revenue Code, a stock option having an exercise price less than the fair market value of the common stock determined as of the option grant date constitutes a deferred compensation arrangement. This typically will result in adverse tax consequences for the option recipient and a tax withholding responsibility for the company. It is indeed very significant to value the stock options correctly at the fair market value complying with 409A valuation rules to avoid such adverse tax consequences.
  • Be aware of transfer pricing regulations while entering in to any transactions with related parties. In general, the U.S. transfer pricing regulations require that transactions between related parties take place at the same prices that would be expected had the same transactions taken place between unrelated parties. Regulations describe a set of specified methods that may be used to determine whether the prices charged in controlled transactions are consistent with those that would be expected at arm’s length. Unspecified methods may also be used if they are likely to yield a more accurate result than the specified methods.
  • Know the reporting requirements related to signature authority, control, or ownership in foreign financial assets or other business entities in any foreign country. There are various forms that could be applicable based on facts and circumstances of each case such as form TD F 90-22.1, form 8938, form 5471, form 5472, form 8865, form 926, form 3520 and form 3521. Be sure to get the applicability of foreign reporting evaluated in your particular case and comply if applicable.
  • Plan to file your tax returns in time. If due to some reasons the filing of tax returns is extended, be sure to pay the taxes along with the extension. Know that extension of filing the tax return does not extend the date of payment of taxes. Else, you could end up paying interest on late payments.
  • Keep in mind important tax deadlines for your business; some most common tax deadlines are:
    • Due date for filing Income tax returns for most businesses following calendar year as their fiscal year is March 15, if incorporated business and April 15, if unincorporated business.
    • Estimated taxes for income earned or received during the year are paid on quarterly basis and due dates for payment are April 15, June 15, September 15, and January 15.
    • Due date for sales tax payment is either monthly or quarterly depending on state where you are subject to sales tax.
    • Payment of payroll taxes are due either weekly, monthly or quarterly depending on size of payroll. Form W2’s to employees should be issued by January 31. Quarterly federal payroll returns should be filed by the end of subsequent month of the quarter. Annual federal payroll return should be filed by January 31. Also be aware of state payroll forms and returns filing requirements.
    • Deadline to furnish form 1099 to payee is January 31. Form 1099 & 1096 should be mailed to IRS by February 28 if filed by paper, and by April 1 if filed electronically.

Write to Baljeet Singh at baljeetsinghcpa@gmail.com

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Tax Records That Businesses Must Maintain

Most businesses are not informed and make tax record-keeping mistakes. Here’s What You Need to know.

By BALJEET SINGH

Tax records.

There are many benefits for businesses to keep records that include identifying source of receipts, preparing financial statements, monitoring business progress, obtaining financing among others. From income tax prospective keeping proper records helps businesses to prepare tax returns, keep track of the deductible expenses and support income/expenses reported on the tax returns. In fact, the U.S. tax law requires businesses to maintain records, provide substantiation to deductions claimed on the tax return and provide special substantiation to certain deductions. If there is an underpayment of taxes that results from failure to keep adequate books or records or to substantiate items properly, it could result in a penalty of 20% of the underpayment of taxes.

Here are a few simple tips for businesses to comply with the record-keeping requirement from tax prospective to avoid penalties.

  • You should maintain a complete set of books and records for each business that you operate.
  • Except in a few cases, the law does not require any special kind of records. You may choose any record-keeping system suited to your business as far as it clearly shows your income and expenses.
  • The broad categories that your books of accounts should be set up with are Income, expenses, assets, liabilities and equity. Specific sub accounts should be created to track expenses under other various heads.
  • All incomes reflected and deductions claimed on the tax returns must be supported by evidence such as sales invoices, purchase invoices, deposit slips, cancelled checks, time sheets.
  • There are specific record-keeping requirements for deductions claimed for certain expenses that include travel and entertainment expenses, car expenses, gift expenses, assets and charitable contributions. In general, information related to amount, time, place and business purpose or business relationship with the person involved should be noted in a diary, log book, or similar document. In addition to the notation, the deduction should be supported by written evidence like receipts, canceled checks or bills.
  • Any expenses incurred towards travel should have breakdown under various sub categories like travel, meals, lodging or any other expenses. In addition, information should be available on dates of travel, place, days spent for business purpose, business purpose of travel.
  • Any expenses incurred towards entertainment should have classification under various sub categories of expenses and should be totaled on daily basis like meals, travel etc. Further, the records should have information on date, business purpose, location and place, and type of entertainment if it is not apparent from the relevant receipt or invoice.
  • If there is some business discussion and meal or entertainment expenses are incurred either before or after the business discussion, then there should be records in place giving information on date and duration of discussion, place of business discussion, business reason/benefit expected from business discussion and, location and type of entertainment. In addition, the records should include information on name, occupation or other identifying information of person entertained and of those and those who took part in business discussion.
  • There is an exemption from keeping receipts, canceled checks, bills, or other proof for travel and entertainment expenses if either standard mileage/per diem rate is used or expenses are less than $75 or there are transportation expenses for which receipts are not readily available like taxi.
  • Car expenses should be backed up by records maintained on total miles driven as supported by odometer readings, miles driven for business purpose, and the person visited. Further, expenses incurred for gas, oil, parking, toll and other expenses should be noted.
  • Expenses on gifts should be supported by information on date of gift, description, cost, business reason or business benefit from the gift, name and occupation or other identifying information of person receiving the gift and business relationship with him/her.
  • If you have some capital assets in the business for which you claim depreciation on the tax returns, the records should be maintained to support the cost of assets, any additions/improvement to assets and depreciation/deductions claimed for the assets over the years. If assets are sold, the records should be available showing information to support sale and expenses of the sale.
  • Any cash charitable contribution should be substantiated by a bank statement, credit card statement or written acknowledgement from the charity. If cash contribution exceeds $250, written acknowledgement from the charity is requited. Further, an appraisal is required from a certified appraiser if there is donation of property that is valued more than $5,000.
  • There are certain deductions and tax credits that cannot be claimed fully in current year but are carried over to future years. To claim such deductions, the records should be maintained showing the deductions already claimed and unused portion. Examples of such deductions are charitable contributions, capital losses.
  • If you have employees records must include employee’s name, address, SSN, gross payroll, amount of payroll subject to withholding and tax withheld among other details required by IRS. A copy of employee withholding certificates (generally form W4) should be maintained.
  • Generally, the records should be maintained for at least the period covered by statute of limitation which is 3 years after the due date of the tax return or 2 years after the date the tax was paid whichever is later.
  • There are certain deductions for which records should be maintained for longer like records for unreported income that is reportable, loss claim for worthless securities or bad debt, depreciation, and carryovers. The records related to employees should be maintained for at least 4 years after the due date of the tax return or after the tax is paid whichever is later.
  • Certain records should be kept indefinitely. There is no statute of limitation if tax return for particular year is not filed or filed fraudulently and hence such records should be kept indefinitely. Other records that should be kept indefinitely include accounting records, financial statements, certifications like audit, review or compilation reports, IRS letters, private rulings, corporate resolutions.

Though it might not seem an easy task to maintain the books and records; acceptance by IRS of computer generated records and maintaining them using an electronic imaging system make things a lot easier. IRS does accept computer generated records and maintenance using electronic imaging system as long as the system provides necessary information including desired retrieval of the records, required system documentation and controls are in place. Most of the information that businesses need to maintain for certain expenses like travel, entertainment with respect to date, time, place etc. can be done simply by keeping the receipts, invoices, credit card statements and making additional notations on them itself, if needed. Maintaining a separate credit card for businesses is a great way to track business expenses separately. Most of the documentary evidence required to be maintained for fixed assets can be done simply by keeping purchase and sales invoices, real estate closing statements and canceled checks.

The bottom line is that it is business’ responsibility to maintain the required books and records and to keep them safe. By simply setting a proper system in place for bookkeeping, keeping documentary evidence, keeping diary or log book and taking notations in diary and/or other documentary evidence, businesses can comply with most of the record-keeping requirements and avoid the potential underpayment penalties.    

Introduction to the types of business entities, their formation and taxation

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“Nobody likes taxes, but they’ve been around forever. Taxes date back all the way back to the year one, when baby Jesus was visited by two wise men and an IRS agent, who demanded half the family’s frankincense.” -Jimmy Kimmel.

So there is nothing much we could do about existence of taxes and the fact that they are going to remain forever but what we could do is trying to know more about various options available when we start our business as to type of business structure available, their tax impact so that we go for one that best suits our circumstances. To start with, it will be interesting to go through the following to understand the types of business entities that are available.

  1. Sole Proprietorship – Sole proprietorship refers to the form of business when someone in his/her individual capacity engages in to business activity. There are no legal formalities required to start sole proprietorship except that registration may be required with city or county. All the income from business as a sole proprietorship is reported on individual tax returns of the owner as income from business. The main advantage of this form of business is that it is simple to start. The disadvantage is that the individual is personally liable for the liabilities of the business.
  2. Partnerships – When two or more person join together to do business then it is called a partnership. Like sole proprietorship there are no legal formalities required to start a business in partnership. Typically partners enter in to a formal agreement that specifies the terms of the partnership. Partnerships are flow through entities which means that the income of the partnership is not taxed at partnership level and flows to individual tax returns of the partners for their respective share of income where they pay taxes for their respective share though partnership does need to file a separate tax return which is an information return. Partners are jointly and severally personally liable for the liabilities of the partnership. There are two kind of partnerships; general and limited partnership. In general partnership all the partners have unlimited liability whereas in limited partnership, which needs to have one general partner at least, only general partners have unlimited liability. Some states do permit LLP (limited liability partnerships) to protect the liability of general partners.
  3. Limited Liability Companies (LLC’s) – LLC is formed under the State law by filing charter of the Company with the Secretary of State. The owners of the LLC’s are called members. Some states allow one member LLC to be formed.  One member LLC is a disregarded entity as per the tax laws that means LLC does not file any separate tax returns and all the income of the LLC is reported on member’s personal tax returns. Two or more members LLC’s are taxed like partnerships i.e. they are flow through entities which means that the income of the LLC is not taxed at the corporate level and flows to individual tax returns of the members for their respective share of income where they pay taxes for their respective share though LLC does need to file a separate tax return which is an information return. LLC, with one or more members, can choose to be taxed as a C-Corporation by making a specific election with the IRS within the specified time limit. The liability of the members is limited.
  4. C Corporation – C-corporation is formed under state law by filing charter of the company with the Secretary of the State. The owners of the Corporation are called stockholders. The income of the C-Corporation is taxed at a corporate level and if any distribution is made to stockholder after tax paid income that also becomes subject to taxes as dividend income. The stockholder of C-corporation has limited liability.
  5. S Corporations- S Corporation is initially formed as a C-Corporation under state law by filing a charter document with the Secretary of State and thereafter, an election if filed with the IRS requesting the entity to be taxed as S Corporation. The owners are called stockholders and have limited liability. S Corporation is a flow through entity which means the income of the S Corporation is not taxed at corporate level and flows to individual tax returns of the partners for their respective share of income. S Corporation needs to file a separate return which is an information return.