Small business guide to taxes 03032010

TSR Consulting, Inc. (The Snelling Report) 1

Small Business Guide to Taxes

TSR Consulting, Inc.Debbie Snelling, CEO

voice 404-944-3172 ♦ e-fax 425-944-3178http://thesnellingreport.com

[email protected] & Twitter: SnellingReport


StructureBusiness structure affects taxThings affecting decision about structure

Exit strategySuccession planningEase of entry and operationTaxes


Sole ProprietorEasiest to form

No state license or registrationLow cost of start upFederal Taxpayer Identification Number (TIN) not required

unless if hire employees or other limited circumstancesNo separate bank account necessary

Easier record keeping if separate bank account, so it’s advisable to have one

Bank are often now requiring a business license to open account

File taxes as usual with additional formsUnlimited liability for yourself. All your assets may be at risk.Tax = income tax (at your tax bracket) + Self Employment

tax (15.3%). Combined tax could be 40% or more!


PartnershipEasy to form

No state license or registration necessaryMust get federal Taxpayer Identification Number (TIN)

Separate bank account for partnershipBank will require TIN and business license

Must file separate tax returnItems of income and expense flow through to partners’ personal

returnBusiness income is taxable to partner currentlyBusiness losses are, generally, deductible to partner currently

Unlimited liability of partners (unless Limited Liability Partner)

Tax = income tax (at your tax bracket) + Self Employment tax (15.3%). Combined tax could be 40% or more!


Limited Liability Company (LLC)Form by filing LLC documents with Secretary of StateCorporation with ability to decide tax structureCorporate entity provides limited liability for

members/shareholdersMust register and file annually with Secretary of State

Must get federal Taxpayer Identification Number (TIN) if other than sole proprietor

Check the box for taxDefault for one member = sole proprietorDefault for more than one member = partnershipCheck the box option to be taxed as corporationIf decide to be taxed as corporation, can elect S-corp


Limited Liability Company (LLC)Tax return filing depends on tax structure

Separate return required if other than sole proprietor

Limited liability for membersTax, generally, not subject to SE tax if

partnershipRecent court cases allowed deduction of

business loss for LLC memberExpect IRS to try to push for SE tax on LLC

members with active participation


Corporation (C corporation)Form by filing corporation documents with Secretary of StateBest if long term goal is to offer the share to the publicMust obtain separate bank account

Must get federal TIN and business licenseMust register and file annually with Secretary of StateMust have Board of Directors and prepare annual Board minutesMust file separate tax returnCorporation pays taxes on its net incomeDividends paid are not deductible to the corporation

Dividends reduce the equity of the corporation Because no tax deduction is allowed, the corporation pays taxes on

amounts paid as dividends Recipients of dividend income (you), pay taxes on the dividends Dividends, therefore, are taxed twice – corporation and you


S-Corporation Form by filing corporation documents with Secretary of State Corporation with limits to number and types of shareholders Must obtain separate bank account

Must get federal TIN and business license Must register and file annually with Secretary of State Must have Board of Directors and prepare annual Board minutes Must file separate tax return

Items of income/expense pass through to shareholders Because the shareholder (you) pays taxes on the net income (or deducts the

net loss), items returned to you from profits are taxed only once Salary must be paid to officers

Unless net income of the business is nominal, you must pay a salary to yourself

Salary requires payroll tax returns and deposits FICA (Social Security & Medicare) tax only against amount of salary Net income of business not subject to Self Employment tax (only the salary is)

Limited liability for shareholders


Business ExpensesAll expenses related to business are

deductibleExpenses must be documented

ReceiptsMileage log

Some expenses are limitedMeals and entertainmentClub duesAuto expenses


What business expenses are deductible?Employee or contractor payInsuranceInterest

Investment interest is not a business expense unless you are a professional trader

Legal and professional feesFees related to your business are deducted from business incomeFees related to your personal life may be deductible as an itemized

deductionRetirement plans

For yourself and your employees , e.g. SEP (Simplified Employee Pension) or SIMPLE (Savings Incentive Match for Employees)

RentTravel and entertainment, if certain conditions are met


What business expenses are deductible?Business use of your homeAdvertisingBank feesEducation expenses Internet accessCell phone servicePenalties or fines you pay for late performance or

nonperformance of a contractLicenses and regulatory feesRepairs that keep your business property in normal operating

conditionProfessional dues Subscriptions for professional journals and publications


Expenses you cannot deductBribes or kickbacksDues to business, social, athletic, luncheon,

sporting, airline, and hotel clubsLobbying expensesPenalties or fines you pay to a government

agency or instrumentality because you broke (or failed to comply with) the law

Personal, living and family expensesPolitical contributionsRepairs that add to the value of your property or

significantly increase its life.


Car and truck expensesActual expenses or standard mileage rateActual expenses include depreciation, gas,

insurance, repairs and maintenance, parking and tolls, etc.

Standard mileage rate includes all items in actual expense2009 standard mileage rate = $0.55/mile for businessParking and tolls still deductible separately

Mileage log must be maintained whether using actual expense method or standard mileage method

Business use of your car is deductible. Personal use is not deductible.


What is business mileage?Local transportation expensesGetting from one workplace to anotherVisiting clients or customersGoing to tradeshows, meetings or

conventions away from your regular workplace

Out of town travel for business in your vehicle


DepreciationBusiness assets with a life of greater than one year must be

capitalized It must be property you own It must be used in your trade or business

Deduction is taken for depreciation over the life of the propertyLife is generally prescribed by IRSAdditional first year depreciation may be taken in certain

circumstancesInventory is not depreciable because it is for resale, not for use

in your businessWhen items are sold from inventory, they are deductible as a cost

of selling Items withdrawn from inventory for personal use are not

deductible


Sec 179 depreciation$250,000 can be deducted in the first year as

additional (Sec 179) depreciationLimited to the amount of net income of your

business Sec 179 depreciation cannot create a business loss

Reduction in the amount by the cost amount which exceeds $800,000

Limitation for passenger automobiles ($2,960 in 2008)

Sec 179 depreciation deduction scheduled to go to $125,000 after 2009.


Repairs, maintenance or business asset?Repairs and maintenance are deducted in the

current tax yearIn order to require capitalization, the

expense mustincrease the value of your property,make it more useful,or lengthen its useful life

Capitalization requires that you depreciate the asset over the prescribed life, e.g. 5 years for a computer , 7 years for a desk (see the Depreciation section)


When are entertainment expenses deductible?General rule

You can deduct ordinary and necessary expenses to entertain a client, customer, or employee if the expenses meet the directly-related test or the associated test.

Entertainment includes any activity generally considered to provide entertainment, amusement, or recreation, and includes meals provided to a customer or client.

An ordinary expense is one that is common and accepted in your field of business, trade, or profession.

A necessary expense is one that is helpful and appropriate, although not necessarily required, for your business.


Entertainment expense tests Directly-related test

Entertainment took place in a clear business setting, OR Main purpose of entertainment was the active conduct of business, AND You did engage in business with the person during the entertainment period and You had more than a general expectation of getting income or some other specific

business benefit

Associated test Entertainment is associated with your trade or business, and Entertainment directly precedes or follows a substantial business discussion

Other rules You cannot deduct the cost of your meal as an entertainment expense if you are

claiming the meal as a travel expense You cannot deduct expenses that are lavish or extravagant under the

circumstances You generally can deduct only 50% of your unreimbursed entertainment expenses


Self employment taxNet business income is subject to income tax and self

employment taxNet earnings subject to self employment is net business

income x 92.35% (100% less 7.65%)Income tax rate depends upon your tax bracketSelf employment tax is 15.3% (7.65% x 2)

12.4% Social Security (6.2% x 2)2.9% Medicare (1.45% x 2)Note that this is both the employee and employer side of what

would be FICA tax on your paycheck from your employerMaximum earnings subject to self employment tax

Social Security portion 2009: $106,800Medicare portion unlimited


Start-up CostsStart-up costs paid or incurred after October 22, 1994Up to $5,000 may be deducted in the year the business begins

A special election was required to be attached to be attached to the tax return

Regulations finalized on July 8, 2008 eliminated this requirement for start-up costs incurred after September 8, 2008

These regulations also put in place a “deemed made” election standard for start-up costs paid or incurred after October 22, 1994 provided that the period of limitations on assessment of tax has not expired for the year the election is deemed made

The $5,000 is reduced by the amount by which total start-up costs exceed $50,000

Amounts not deductible currently must be amortized over 15 years

Start-up costs prior to October 22, 1994 were not deductible


Self employment tax example(includes Sole Proprietor, Partnership (flowing to your personal return), and LLC (unless LLC is taxed as a corporation))

Self Employment (SE Tax) 15.3%Social Security 6.20%Medicare 1.45%

Subtotal 7.65%Employer Match x2 (you are the employer)Total 15.30%

Net Business Income $ 60,000SE Tax Rate 15.3%SE Tax $ 9,180

You still have to pay Income Tax!


Self employment tax example (continued)Net Income from Self Employment $ 60,000½ of self employment tax ($60,000 x 15.3% x ½) ( 4,590)Adjusted Gross Income (AGI) $ 55,410

examples uses 2009 tax rates, standard deduction and personal exemption

Standard Deduction (single taxpayer) ( 5,700)Personal Exemption (no dependents) ( 3,650)Taxable Income $ 46,060Income Tax (25% tax bracket) $ 7,703SE Tax ($60,000 x 15.3%) 9,190Total Federal Tax $ 16,883

28.14% of $60K!! YOU STILL HAVE TO PAY STATE INCOME TAX


Paying taxes and underpayment penaltiesEstimated tax payments must be made quarterlyAdjust withholding if you or spouse have a jobMake estimated tax payments

4/15, 6/15, 9/15, 1/15Federal and state estimated payments

Penalty for underpayment of estimated taxPenalty is calculated like interest - rates change monthlyUsually, 25% is due each quarterAn annualized method may be usedMust pay 90% of current year tax or 100% or prior year taxIf pay less than required minimum estimates, penalty is

calculated on daily underpayment


Penalties for failure to file or payPenalty for failure to file

Individuals: 5%/month with a maximum of 25%, but not less than the minimum

Partnerships and S-corporations: $50/partner or shareholder /month with a $250 maximum, but not less than the minimum

Minimum penalty was revised for returns required to be filed after 2008 If not filed within 60 days of the due date (including extensions) Individuals

lesser of $135 or the amount of tax required to be shown on the return Partnerships and S-corporations

$89/partner or shareholder /month for 12 months

Penalty for failure to pay0.5%/month with no maximum

Penalties may be waived or abated if due to reasonable cause


Tax Planning for Business is EssentialEvery major corporation has tax professionals

employed on a full time basis to do tax planning and to comply with tax rules, regulations, and deadlines.

Big 4 accounting firms charge a minimum of $150/hour for fresh college graduates with no experience.

Corporate structure pays a key role in tax planning.

In the example above, every dollar of deduction or every dollar of revenue deferred will save over 40% in taxes (25% tax bracket + 15.3% SE Tax). This is still before paying state income tax!


IRS Circular 230 DisclosureTo ensure compliance with any requirements

imposed by the IRS, we inform you that the federal tax advice (if any) contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

Small business guide to taxes 03032010

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