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If you’re a small business owner, you probably have an idea of how taxes can affect your business. But unless you’re a tax expert, you might not realize all the ways a small business can benefit from both new and current tax laws. Let small business and tax expert Barbara Weltman show youas a small business ownerhow to maximize deductions and reduce your ...
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If you’re a small business owner, you probably have an idea of how taxes can affect your business. But unless you’re a tax expert, you might not realize all the ways a small business can benefit from both new and current tax laws. Let small business and tax expert Barbara Weltman show youas a small business ownerhow to maximize deductions and reduce your payments to the minimum.
J.K. Lasser’s Small Business Taxes, Sixth Edition gives you a complete rundown of small business tax planning in plain English, helping you take advantage of every tax break you’re entitled to. Focusing on strategies that help you use deductions, credits, and other benefits to save during tax time, this comprehensive guide is all you need to keep up with Uncle Sam. The invaluable advice in this book will show you how your actions in business today can affect your bottom line from a tax perspective tomorrow.
In this volume, you’ll find:
Part 1: Organization.
1. Business Organization.
2. Tax Year and Accounting Methods.
3. Recordkeeping for Business Income and Deductions.
Part 2: Business Income and Losses.
4. Income or Loss from Business Operations.
5. Capital Gains and Losses.
6. Gains and Losses from Sales of Business Property.
Part 3: Business Deductions and Credits.
7. Employee Compensation: Salary, Wages, and Employee Benefits.
8. Travel and Entertainment Expenses.
9. Car Expenses.
10. Repairs and Maintenance.
11. Bad Debts.
13. Taxes and Interest.
14. First-Year Expensing and Depreciation, Amortization, and Depletion.
15. Advertising Expenses.
16. Retirement Plans.
17. Casualty and Theft Losses.
18. Home Office Deductions.
19. Medical Coverage.
20. Deductions for Farmers.
21. Miscellaneous Business Deductions.
22. Deductions for Alternative Minimum Tax.
23. Roundup of Tax Credits.
Part 4: Tax Planning for Your Small Business.
24. Income and Deduction Strategies.
25. Other Taxes.
26. Online Filing and Information.
Appendix: Information Returns.
If you have a great idea for a product or a business and are eager to get started, do not let your enthusiasm be the reason you get off on the wrong foot. Take a while to consider how you will organize your business. The form of organization your business takes controls how income and deductions are reported to the government on a tax return. Sometimes you have a choice of the type of business organization; other times circumstances limit your choice. If you have not yet set up your business and do have a choice, this discussion will influence your decision on business organization. If you have already set up your business, you may want to consider changing to another form of organization. In this chapter you will learn about:
Sole proprietorships (including independent contractors)
Partnerships and limited liability companies
S corporations and their shareholder-employees
C corporations and their shareholder-employees
Factors in choosing your form of business organization
Forms of business organization compared
Changing your form of business
For a further discussion on worker classification, see IRS Publication 15-A, Employer's Supplemental Tax Guide.
If you go intobusiness for yourself and do not have any partners, you are considered a sole proprietor. You may think that the term proprietor connotes a storekeeper. For purposes of tax treatment, proprietor means any unincorporated business owned entirely by one person. Thus, the category includes individuals in professional practice, such as doctors, lawyers, accountants, and architects. Those who are experts in an area, such as engineering, public relations, or computers, may set up their own consulting businesses and fall under the category of sole proprietor. The designation also applies to independent contractors.
There are no formalities required to become a sole proprietor; you simply conduct business. You may have to register your business with your city, town, or county government by filing a simple form stating that you are doing business as the "Quality Dry Cleaners" or some other business name. This is sometimes referred to as a DBA.
From a legal standpoint, as a sole proprietor, you are personally liable for any debts your business incurs. For example, if you borrow money and default on a loan, the lender can look not only to your business equipment and other business property but also to your personal stocks, bonds, and other property. Some states may give your house homestead protection; state or federal law may protect your pensions and even Individual Retirement Accounts (IRAs). Your only protection for your personal assets is adequate insurance against accidents for your business and other liabilities and paying your debts in full.
One type of sole proprietor is the independent contractor. To illustrate, suppose you used to work for Corporation X. You have retired, but X gives you a consulting contract under which you provide occasional services to X. In your retirement, you decide to provide consulting services not only to X, but to other customers as well. You are now a consultant. You are an independent contractor to each of the companies for which you provide services.
More precisely, an independent contractor is an individual who provides services to others outside an employment context. The providing of services becomes a business, an independent calling. In terms of claiming business deductions, classification as an independent contractor is generally more favorable than classification as an employee. (See "Tax Treatment of Income and Deductions in General," later in this chapter.) Therefore, many individuals whose employment status is not clear may wish to claim independent contractor status. Also, from the employer's perspective, hiring independent contractors is more favorable because the employer is not liable for employment taxes and need not provide employee benefits. Federal employment taxes include Social Security and Medicare taxes under the Federal Insurance Contribution Act (FICA) as well as unemployment taxes under the Federal Unemployment Tax Act (FUTA).
You should be aware that the Internal Revenue Service (IRS) aggressively tries to reclassify workers as employees in order to collect employment taxes from employers. The IRS agents are provided with a special audit manual designed to help the agents reclassify a worker as an employee if appropriate. The key to worker classification is control. In order to prove independent contractor status, you, as the worker, must show that you have the right to control the details and means by which your work is to be accomplished. You may also want to show that you have an economic stake in your work (that you stand to make a profit or loss depending on how your work turns out). It is helpful in this regard to supply your own tools and place of work, although working from your home, using your own computer, and even setting your own hours (flex time) are not conclusive factors that preclude an employee classification. Various behavioral, financial, and other factors can be brought to bear on the issue of whether you are under someone else's control. You can learn more about worker classification in IRS Publication 15-A, Employer's Supplemental Tax Guide.
There is a distinction that needs to be made between the classification of a worker for income tax purposes and the classification of a worker for employment tax purposes. By statute, certain employees are treated as independent contractors for employment taxes even though they continue to be treated as employees for income taxes. Other employees are treated as employees for employment taxes even though they are independent contractors for income taxes.
There are two categories of employees that are, by statute, treated as non-employees for purposes of federal employment taxes. These two categories are real estate salespersons and direct sellers of consumer goods. These employees are considered independent contractors (the ramifications of which are discussed later in this chapter). Such workers are deemed independent contractors if at least 90 percent of the employees' compensation is determined by their output. In other words, they are independent contractors if they are paid by commission and not a fixed salary. They must also perform their services under a written contract that specifies they will not be treated as employees for federal employment tax purposes.
Some individuals who consider themselves to be in business for themselves-reporting their income and expenses as sole proprietors-may still be treated as employees for purposes of employment taxes. As such, Social Security and Medicare taxes are withheld from their compensation. These individuals include:
Agent-drivers or commission-drivers engaged in the distribution of meat products, bakery products, produce, beverages other than milk, laundry, or dry-cleaning services
Full-time life insurance salespersons
Homeworkers who personally perform services according to specifications provided by the service recipient
Traveling or city salespersons engaged on a full-time basis in the solicitation of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar businesses
Full-time life insurance salespersons, homeworkers, and traveling or city salespersons are exempt from FICA if they have made a substantial investment in the facilities used in connection with the performance of services.
One-Member Limited Liability Companies
Every state allows a single owner to form a limited liability company (LLC) under state law. From a legal standpoint, the LLC gives the owner protection from personal liability (only business assets are at risk from the claims of creditors) as explained later in this chapter. But from a tax standpoint, a one-member LLC is treated as a "disregarded entity" (the owner can elect to have the LLC taxed as a corporation, but there is probably no compelling reason to do so). If the owner is an individual (and not a corporation), all of the income and expenses of the LLC are reported on Schedule C of the owner's Form 1040. In other words, for tax purposes, the LLC is treated just like a sole proprietorship.
Tax Treatment of Income and Deductions in General
Sole proprietors, including independent contractors and statutory employees, report their income and deductions on Schedule C, see Profit or Loss From Business (Figure 1.1). The net amount (profit or loss after offsetting income with deductions) is then reported as part of the income section on page one of your Form 1040. Such individuals may be able to use a simplified form for reporting business income and deductions: Schedule C-EZ, Net Profit From Business see (Figure 1.2). Individuals engaged in farming activities report business income and deductions on Schedule F, the net amount of which is then reported in the income section on page one of your Form 1040. Individuals who are considered employees cannot use Schedule C to report their income and claim deductions. See page 21 for the tax treatment of income and deductions by employees.
Partnerships and Limited Liability Companies
If you go into business with others, then you cannot be a sole proprietor. You are automatically in a partnership if you join together with one or more people to share the profits of the business and take no formal action. Owners of a partnership are called partners.
There are two types of partnerships: general partnerships and limited partnerships. In general partnerships, all of the partners are personally liable for the debts of the business. Creditors can go after the personal assets of any and all of the partners to satisfy partnership debts. In limited partnerships, only the general partners are personally liable for the debts of the business. Limited partners are liable only to the extent of their investments in the business plus their share of recourse debts and obligations to make future investments.
General partners are jointly and severally liable for the business's debts. A creditor can go after any one partner for the full amount of the debt. That partner can seek to recoup a proportional share of the debt from other partner(s).
Partnerships can be informal agreements to share profits and losses of a business venture. More typically, however, they are organized with formal partnership agreements. These agreements detail how income, deductions, gains, losses, and credits are to be split (if there are any special allocations to be made) and what happens on the retirement, disability, bankruptcy, or death of a partner. A limited partnership must have a partnership agreement that complies with state law requirements.
Another form of organization that can be used by those joining together for business is a limited liability company (LLC). This type of business organization is formed under state law in which all owners are given limited liability. Owners of LLCs are called members. These companies are relatively new but have attracted great interest across the country. Every state now has LLC statutes to permit the formation of a LLC within its boundaries. Most states also permit limited liability partnerships (LLPs)-LLCs for accountants, attorneys, doctors, and other professionals-which are easily formed by existing partnerships filing an LLP election with the state. And Delaware now permits multiple LLCs to operate under a single LLC umbrella called a series LLC. The debts and liabilities of each LLC remain separate from those of the other LLCs, something that is ideal for those owning several pieces of real estate-each can be owned by a separate LLC under the master LLC. At present, state law is evolving to determine the treatment of LLCs formed in one state but doing business in another.
As the name suggests, the creditors of LLCs can look only to the assets of the company to satisfy debts; creditors cannot go after members and hope to recover their personal assets. For federal income tax purposes, LLCs are treated like partnerships unless the members elect to have the LLCs taxed as corporations. Tax experts have yet to come up with any compelling reason for LLCs to choose corporate tax treatment, but if it is desired, the businesses just check the box on a special form (IRS Form 8832. See Figure 1.3). For purposes of our discussion throughout the book, it will be assumed that LLCs have not chosen corporate tax treatment and so are taxed the same way as partnerships. A one-member LLC is treated for tax purposes like a sole proprietor if it is owned by an individual who reports the company's income and expenses on his or her Schedule C.
Tax Treatment of Income and Deductions in General
Partnerships and LLCs are pass-through entities. They are not separate taxpaying entities; instead, they pass income, deductions, gains, losses, and tax credits through to their owners. The owners report these amounts on their individual returns. While the entity does not pay taxes, it must file an information return with IRS-Form 1065, U.S. Return of Partnership Income, to report the total pass-through amounts. Even though the return is called a partnership return, it is the same return filed by LLCs with two or more owners. The entity also completes Schedule K-1 of Form 1065 (Figure 1.4), a copy of which is given to each owner. The K-1 tells the owner his or her allocable share of partnership/LLC amounts.
There are two types of items that pass through to an owner: trade or business income or loss and separately stated items. A partner's or member's share is called the distributive share. Trade or business income or loss takes into account most ordinary deductions of the business-compensation, rent, taxes, interest, and so forth. Guaranteed payments to an owner are also taken into account when determining ordinary income or loss. From an owner's perspective, deductions net out against income from the business, and the owner's allocable share of the net amount is then reported on the owner's Schedule E. Figure 1.5 shows a sample portion of Schedule E on which a partner's or member's distributive share is reported.
Separately stated items are stand-alone items that pass through to owners apart from the net amount of trade or business income. These are items that are subject to limitations on an individual's tax return and must be segregated from the net amount of trade or business income. They are reported along with similar items on the owner's own tax return.
Excerpted from J.K. Lasser's 1001 Deductions and Tax Breaks by Barbara Weltman Excerpted by permission.
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