What Can I Do In My Business Before Year-End to Minimize Taxes?

What Can I Do In My Business Before Year-End to Minimize Taxes?

December 31st will be here before you know it and once the clock ticks January 1, most tax planning for 2020 is done.

With that being said, we still have plenty of time to get tax savings in before 12/31, we just need to act now.

Here are five powerful business tax deduction strategies that you can easily understand and implement before the end of 2020.

Prepay Expenses Using the IRS Safe Harbor

IRS regulations contain a safe-harbor rule that allows cash-basis taxpayers to prepay and deduct qualifying expenses up to 12 months in advance without challenge, adjustment, or change by the IRS.

  • Under this safe harbor, your 2020 prepayments cannot go into 2022. This makes sense, because you can prepay only 12 months of qualifying expenses under the safe-harbor rule.
  • Qualifying Expenses: Lease payments on vehicles, rent payments (office or machinery), and business insurance premiums.
  • Example: You pay $2,000 per month in rent and would like a $24k deduction this year. On Thursday, 12/31/2020 you mail a rent check for $24,000 to cover all of your 2021 rent.
    • You deduct $24,000 (the year you paid the money).
    • The landlord reports taxable income of $24,000 in 2021 (the year they received the money).
    • A win-win situation, just don’t surprise your landlord because if they receive the money in 2020 they will need to pay taxes on that in 2020.

Stop Billing Customers, Clients, and Patients

Here is one rock-solid, time-tested, easy strategy to reduce your taxable income for this year: stop billing your customers, clients, and patients until after December 31, 2020. (We assume here that you or your corporation is on a cash basis and operates on the calendar year.)

  • Customers, clients, patients, and insurance companies generally don’t pay until billed. Not billing customers and patients is a time-tested tax-planning strategy that business owners have used successfully for years.
  • Example: A business attorney generally bills his clients at the end of each week; however, in December he sends no bill. Instead he gathers up those bills and sends them the first week of January. Bingo! They just postponed paying taxes on their December 2020 income by moving that income to 2021.
    • Caution: If you have clients that are known to have issues getting you paid in time this is a strategy you likely will not to use for them. Most importantly you want to ensure you still get paid. 

Buy Office Equipment

Planning to make some equipment purchases? Do it now instead of later.

  • With bonus depreciation now at 100 percent along with increased limits for Section 179 expensing, buy your equipment or machinery and place it in service before December 31, and get a deduction for 100 percent of the cost in 2020.
  • Qualifying bonus depreciation and Section 179 purchases include new and used personal property such and machinery, equipment, computers, desks, chairs, other furniture, and certain qualifying vehicles.

Use Your Credit Cards

Assuming you have a business credit card, you get the deduction on the day of charge, not when paid.

  • If you are a single-member LLC or sole prop, the day you charge a purchase to your business or personal credit card is the day you deduct the expense. Therefore, as a Schedule C taxpayer, you should consider using your credit card for last-minute purchases of office supplies and other business necessities.
  • If you operate your business as a corporation, and if the corporation has a credit card in the corporate name, the same rule applies: the date of charge is the date of deduction for the corporation.
  • But if you operate your business as a corporation and you are the personal owner of the credit card, the corporation must reimburse you if you want the corporation to realize the tax deduction, and that happens on the date of reimbursement. Thus, submit your expense report and have your corporation make its reimbursements to you before midnight on December 31. Look at our accountable plan article and Podcast episode for more information on this.
  • Caution: Don’t just spend to spend. Ultimately you do not want to be wasting money on things you do not need but if you plan to purchase items in early 2021 why not purchase those now via a CC to get them on the books and pay for it later.

Don’t Assume You Are Taking Too Many Deductions

The IRS code was written the way it was for a reason, so you can utilize it to your advantage. 

  • If your business deductions exceed your business income, you have a tax loss for the year. This a “net operating loss,” or NOL.
  • If you are just starting your business, you could very possibly have an NOL. You could have a loss year even with an ongoing, successful business.
  • What does this all mean? You should never stop documenting your deductions, and you should always claim all your rightful deductions. We have spoken with far too many business owners, especially new owners, who don’t claim all their deductions when those deductions would produce a tax loss.
  • COVID-19 changes the NOL slightly. Two opportunities come from the CARES act:
    • Allows NOLs arising in tax years beginning in 2018, 2019, and 2020 to be carried back five years for refunds against prior taxes.
    • Allows application of 100% of the NOL to the carry back years
    • Previously you could only carry forward your NOL and it could only offset up to 80% of your taxable income in any future year.

Remember, once the calendar rolls over to 2021 the majority of tax planning opportunities get tossed out the window. You have time now, take a couple hours to strategize and implement so you can ensure when you file your tax return you are paying the lease amount in taxes as legally possible!

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

What Is An Accountable Plan and Why Is It Important To My Business?

What Is An Accountable Plan and Why Is It Important To My Business?

You may or may not have ever heard of this thing called an Accountable Plan. It is something we talk about often here at JETRO. Regardless of where you are at, we are going to bring you up to speed in this article!

Do you reimburse yourself for business expenses put on personal accounts or expenses that are business and personal mix? In most cases we know you use your business accounts for business related expenses, but there are always moments when you have to use cash or your personal accounts to pay for something and you want the business to reimburse you.

If you have employees, this applies to reimbursing them as well. It’s important to keep specific records for these occurrences so that reimbursements can be tax free.

What is an Accountable Plan?

A fancy way of saying “reimbursement policy”.

  • Purpose: This is for S Corporation owners that pay for business (or personal and business mix) expenses using their personal accounts.
  • An Accountable Plan is a reimbursement policy and expense reporting system that allows owners and their employees to turn in expense reports to the business for reimbursement in a way that keeps those amounts from being counted as taxable income.
  • It is important to note that if you have an expense that is 100% business related, simply run it through a business account.
  • However, if you have expenses you accidentally paid for personally or expenses that have both a business and personal use (think home office) then you will want to use an accountable plan.

Why Is It Important To Have An Accountable Plan?

Because if you reimburse yourself without an Accountable Plan, that money may be considered taxable income.

How Do I Implement An Accountable Plan?

Below are the steps for establishing an Accountable Plan.

  1. Adopt a written reimbursement policy (Accountable Plan). You can find a sample document here. Keep this in your corporate records. Important to consider:
    • The expense(s) must have a valid business purpose.
    • Owners (and employees) must be able to identify the expense with a receipt and have documentation (substantiation) that supports it.
    • You should provide documentation in a timely manner.
    • Advances can be given to provide for anticipated expenses but any unused funds or non business items must be returned.
  2. Create an accountable plan template that you can fill out to determine the reimbursement amount. You can find a sample here.
  3. Make the reimbursement payment. Pay from the business bank account to your personal (or employee’s) bank account.
    • Note: Keep all original reports and substantiation documents for your records.

Example of Common Accountable Plan Expenses

Here are some items we typically see involved in an Accountable Plan reimbursement.

  • Home Office
    • First determine business use percentage by taking square footage of office divided by total home square footage.
    • Multiply business use percentage by all related costs to determine the reimbursement amount. This could include: mortgage interest, property taxes, rent, insurance, utilities, HOA dues, repairs and maintenance, cleaning, lawn care, etc.
  • Automobile (Owned by Employee, NOT Business)
    • First determine business use percentage by taking business miles driven divided by total miles driven and be sure to keep a mileage log.
    • Then use one of two methods:
      • Mileage Method (Required if less than 50% business use): Simply take 57.5 (2020) cents per business mile.
      • Actual Method: Multiply business use percentage by all related costs to determine the reimbursement amount. This could include: loan interest, lease payment, fuel, registrations, car washing, repairs and maintenance, etc.
  • Office Expenses
    • Multiply business use percentage by the cost of: Internet, Cell Phone, etc
  • Others
    • Travel, Parking, Tolls, Business Meals, etc.
    • Any other business related item (whether full or partial) that was paid for personally.
  • Remember: If an item is 100% business use, save the extra effort and simply run it through the business account. This is specifically for business items you accidentally paid for personally or items that are business and personal mix.

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

Coronavirus (COVID-19): PPP Forgiveness and Tax Treatment + EIDL Advance

Coronavirus (COVID-19): PPP Forgiveness and Tax Treatment + EIDL Advance

We wanted to give you an update to the PPP forgiveness as well as tax treatment of both the PPP and EIDL.

With another Coronavirus relief bill possible to happen at some point, know that there may be changes to the way things currently stand.

With that being said, what we outline here is the way things are today but we will be sure to let you know if anything changes.

Paycheck Protection Program (PPP) Forgiveness

The SBA is accepting forgiveness applications for the PPP loan.

  • This process must be done through the bank you received your loan from. Be sure to reach out to your banker to ensure they are accepting the forgiveness applications currently and exactly what they need from you. They will more than likely give you the form along with a list of requested docs they need to complete the process.
  • There are three application types: Form 3508 requires the most calculations, Form 3508EZ requires less calculations and Form 3508S requires close to zero calculations. Lets dive into these:
  • PPP Forgiveness Application – Which form should I use?
    • Form 3508S – Simplified form for those with a loan less than $50,000. In this form you do not need to “show your math” you simply do the computation of the forgivable amount on your own and and report it on the application. If you are using this form you are NOT subject to the salary or full-time equivalent reduction requirements.
    • Form 3508EZ – Available to those that are self-employed with no employees OR those who did not reduce employee salaries by more than 25% and did not reduce employee hours OR those who reduced business activity due to COVID health guidelines and did not reduce salaries by more than 25%.
    • Form 3508 – For those who do not qualify to use Form 3508S or 3508EZ. This form is the most complicated,requiring various calculations around eligible costs, salary or hour reductions, etc.
  • Once the bank receives the application they have 60 days to review it and then the SBA has another 90 days to review.

Paycheck Protection Program (PPP) Tax Treatment

PPP Forgiveness is not taxable but… expenses are not deductible.

  • PPP forgiveness does NOT trigger cancellation of debt meaning that the actual forgiveness of the loan is not taxable.
  • However, here is where things get a little sticky. The expenses for the items that are being forgiven (payroll, rent, utilities, etc) are not deductible per the IRS.
  • Example: You got a PPP loan for $40k, used all of the funds for payroll, and then got the full loan forgiven. You do not need to report income of $40k forgiven, however the $40k you spent on payroll (or other eligible costs) for that forgiven amount is not deductible.
  • This may come as a surprise to some and may be a little frustrating. This is one item that has been addressed in various relief bills that have come to the table but nothing in this area has been passed yet. There is a lot of push for the IRS to reverse this and allow expenses for the items forgiven.

Economic Injury Disaster Loan (EIDL) Advance Tax Treatment

The EIDL was a loan offered by the SBA for businesses suffering from the pandemic. As part of the EIDL loan there was an advance that was available which was technically a grant, up to $10k in value.

  • Since this advance is considered a grant it is not part of the loan that needs to be repaid. Many businesses just received the grant, with no additional loan.
  • There is still no formal guidance from the IRS on whether this specifically will be taxable, however we are assuming it will need to be included in your taxable income.
  • Previously they have made it clear that forgiven SBA loan amounts need to be included as other income.
  • For the time being, assume the grant will be taxable and should something change, great!

Hopefully that is helpful and gives you a good idea on where things stand as it comes to both the PPP loan and the EIDL advance.

As mentioned there have been talks of an additional COVID-19 relief package being passed which may very well change some of the information addressed here however as of now nothing has been agreed upon or passed by Congress.

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

What Is a 1099-NEC and What Do I Need To Know About 1099s?

What Is a 1099-NEC and What Do I Need To Know About 1099s?

If you have been in business for at least a year you have heard of this thing called a 1099. You may have done nothing about them, you may not know what it means but others tell you to send one, or you may being doing them religiously every year and know they can be pain.

Wherever you are in that process we are going to break down everything you need to know about 1099s along with the new Form 1099-NEC for 2020.

What is Form 1099?

A 1099 is an informational filing form used to report non salary income to the IRS.

  • There are over 15 different types of 1099 forms that are used for various purposes.
  • Examples of other 1099 Forms:
    • 1099-INT: Financial institutions are required to file this form if they pay you more than $10 in interest during the year.
    • 1099-K: Issued by third-party payment processors (Ex: Credit card, PayPal, etc) if payments over the year total $20k or more.
    • 1099-DIV: This form reports distributions, such as dividends, capital gain distributions, etc.
    • 1099-B: Happens when you sell stock, showing the date of the sale, cost basis, etc.
    • 1099-G: Used to report unemployment compensation, state tax refunds, etc.
    • 1099-R: Reports a distribution from a retirement plan.
  • The most common that we see business owners needing to deal with are the 1099-MISC and 1099-NEC so that is what we are discussing on this blog post.

What is a 1099-MISC vs 1099-NEC?

The 1099-NEC is new starting tax year 2020. Before this new form, contractor payments were included on the 1099-MISC.

  • 1099-NEC: New form that is used to report independent contractor income. NEC stands for “non-employee compensation”. Prior to 2020 this activity would have been reported on Box 7 of the 1099-MISC.
  • 1099-MISC: This form has not gone away, they have just removed the non-employee compensation from it and moved that to the 1099-NEC.  The 1099-MISC will still be used for the other items including: rent, royalties, prizes/awards, etc.
  • Basically if you were use to filing (or receiving) a 1099-MISC for contractors that has just moved to a 1099-NEC. Still required of course, just a new form.
  • 1099-MISC from IRS Website
  • 1099-NEC from IRS Website
  • IRS Instructions for Both 1099-MISC and 1099-NEC

When Do I Need to File a 1099-NEC?

If you paid a contractor $600+ in a year.

  • If you paid a contractor $600+ in total for a year you would need to send them a 1099-NEC. This could include an individual, company, vendor, etc. Note: This is an accumulative, so if you send three payments of $250 for a total of $750 throughout the year, a 1099-NEC would be required.
  • Exceptions (1099-NEC NOT required to be filed):
    • Payments to C or S Corporations
    • Employees – You should be submitting a W-2 for all employees.
    • Payments for merchandise, freight, or storage.
    • Payments made via Credit Card or PayPal – Instead the merchant process would report those to the vendor via 1099-K.
    • Note: The C or S Corporation exception does not apply for payments to attorneys for legal services.
  • The person that is paying the contractor is the one that files the 1099-NEC. Here is the typical process:
    • Step 1 Collect a W9 from all contractors you pay (even if under $600, as it might get above that with future payments).
    • Step 2 – If a 1099-NEC is required (see notes above) then you as the business would prepare it. All information needed to prepare a 1099 would be found on the W9.
    • Step 3 – Send a copy of the Form 1099-NEC form to the contractor.
    • Step 4 -File a copy of the Form 1099-NEC with the IRS.
  • Note if you are contractor that has received a 1099-NEC you must report this income (of course) on your tax return. The IRS gets a copy of the same form and will match to ensure they see that income reported.

When Is The 1099-NEC Filing Deadline?

1099-NEC’s must be filed with the IRS and sent to the recipient by January 31st of the following year.

 

Note: If January 31st falls on the weekend it would be the next business day.

What Are The Penalties For Not Filing A 1099-NEC?

This depends on how late you are…

  • File within 30 days past deadline: $50 per
  • File more than 30 days late but before August 1st: $110 per
  • File after August 1 or not at all: $270 per
  • Intentional Disregard: $550 per

1099-MISC and 1099-NEC Summary

This article focuses on these two 1099 forms specifically, if you are looking for more information on other variations of 1099 forms, reach out to our team.

  • Starting in 2020 independent contractor or non-employee compensation will be filed on 1099-NEC instead of 1099-MISC.
  • Be sure to always grab a W9 from all independent contractors you pay. You never know when you may need it.
  • Forms are due to both the IRS and contractor by January 31st.
  • Total payments throughout the year totaling $600 or more trigger the form requirement, unless certain exceptions are met.
  • Need help filing? Reach out to us or check out the software we use, Track1099.

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

Tax Minimization for Attorneys – As An Attorney How Can I Pay the Least Amount in Taxes As Legally Possible?

Tax Minimization Strategies For Attorneys

Our Founder Mike Jesowshek, CPA recently connected with Darren Wurz from Wurz Financial to discuss tax minimization strategies for attorneys. 

If you follow us around you know our #1 goal is to ensure that lawyers are paying the least amount in taxes as legally possible.

Here is a recording of the webinar:

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

How Do I Value My Business? What Do I Need To Know If I Plan to Sell?

How Do I Value My Business? What Do I Need To Know If I Plan to Sell?

This is a topic that I have wanted to talk about for awhile now as we see business owner that are looking to sell their business or starting succession planning.

Fortunately I was able to connect with Liz Briggson from Adamy Valuation on our Small Business Tax Savings Podcast.

You do not have to miss this episode as Liz was able to share a bunch of golden nuggets with us.

Check the episode out below and here are some articles Liz shared as well.

Value Driver One: Higher Profits and Cash Flow – Article

Value Driver Two: Lower Risk – Article

Value Driver Three: Higher Growth Potential – Article

You can reach out to Liz here or hit Mike from our team up and he can give an introduction.

Liz Briggson, CPA, CVA
Website: Adamy Valuation
Email: lbriggson@adamyvaluation.com

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

Top 7 Most Common Bookkeeping Mistakes Made

Top 7 Bookkeeping Mistakes Made

This is Part 8 in our “All About Bookkeeping” series.

If you missed our first seven articles check them out here:

What Is Bookkeeping and Why Do I Need Bookkeeping For My Business?

What Are Bookkeeping Debits, Credits, and Chart of Accounts?

What Is Cash and Accrual Accounting?

What Is An Income Statement vs Balance Sheet?

How Do I Read An Income Statement and Why Is It Important?

How Do I Read A Balance Sheet and Why Is It Important?

What is the Statement of Cash Flows? Any Other Important Financial Statements?

As you can see we have covered a lot of ground in this “All About Bookkeeping” series. To finish it up we have something that I think is extremely important, understanding and realizing the common mistakes business owners make, so you can avoid them!

Before getting into that, I want to forewarn you. I could do articles on bookkeeping mistakes to make up years worth of content. That would be painful for both you and me so my goal here is to give you a glimpse of some of the most common or top mistakes that we see and want you to be ware of.

Mistake # 1

Not doing bookkeeping on a regular basis and not reading and analyzing your financials.

  • Do regular bookkeeping on at least a monthly basis. Continually putting it off causes you stress, anxiety, and a higher likelihood of mistakes.
  • By doing bookkeeping on a regular basis you now have data available to you that you can use to improve your business. Too many business owners do the bookkeeping but then never analyze their financials. You put the time or money in, utilize the information to help both you and your business succeed.
  • As part of our bookkeeping services we include a video with our client’s financials to walk them through what is going on and help them better understand.

Mistake # 2

Incorrect categorizing or over categorizing transactions.

  • Rushing through and coding transactions to the incorrect account. Example: you might have a rent payment in consulting expense.
  • Be sure you are paying attention and putting transactions in a category that makes sense.
  • Having too many categories can also be confusing and cause a mess. Example: client comes to us with the following expense items: Travel Meals, Travel Hotel, Travel Cab, Travel Air, etc. As you can imagine this is often times more detailed than necessary. Don’t get me wrong, it may make sense for some business but for the majority of small businesses, a simple travel category with all those items combined would be fine.
  • Having too many categories creates unnecessarily long financial statements, often times unreadable or not valuable. For example, seeing $45 for the year in “Travel – Cab” does not provide much value but rather more clutter when it could be wrapped into Travel.

Mistake # 3

Failing to keep receipts for purchases.

  • How many times have you looked at your bank statement and saw a charge wondering what it was for? Having a receipt will make that easy for you.
  • Not only does it help with coding your transactions but it backs up your expenses in the event of an audit.
  • On each receipt write on it: who, what, where, when why, and how much. The more the better should you have questions about it down the road or need to prove business purpose to the IRS.

Mistake # 4

Recording personal items or payments to the owner as business expenses.

  • Have a separate bank account (and credit card, if necessary) that is specific to your business. Run only business expenses through this.
  • If you accidentally pay for something personal on the business account, record it as an owners draw.
  • If you accidentally pay for something business related on your personal account, reimburse yourself from the business with a recording of what it is for.
  • Non-payroll payments to you as the owner generally should be recorded as owner draws (NOT expenses).
  • If you are setup as pass through entity, personal tax payments or estimates you make from the business account are NOT expenses, instead owner draws.

Mistake # 5

Incorrectly recording major purchases and potential corresponding loans with those purchases.

  • If you purchase a major item for your business (Ex: vehicle, machinery, office equipment, usually anything asset over $2,500) these should be recorded on the balance sheet, NOT in an expense account.
  • You take the expense for it through depreciation.
  • If you have any type of loan, that should be recorded as a liability on your balance sheet (NOT income) with principal payments against the loan going to the liability and the interest portion being an expense.
  • Often times we see clients booking auto loans to an automobile expense account. This is a red flag to us. If the vehicle is owned the proper treatment would be to add an asset for the value of the vehicle with a liability for the corresponding loan amount. The payments would be applied to the loan and the expense would come through depreciation of the vehicle.

Mistake #6

Not recording payroll correctly.

  • Payroll is more than just a take-home check. There is taxes, benefits, etc.
  • Ensure that your payroll is being recorded so that it matches your payroll report from your payroll provider. If you use someone like Gusto for payroll, they integrate with most accounting software to help you with this process.
  • At year-end your payroll report should match exactly to your books with the breakdown of Wages and Salaries, Payroll Tax Expenses, Benefits, etc.

Mistake # 7

Being unfamiliar or inexperienced with the entire process.

That is it, we have made it to the end of our “All About Bookkeeping” series. As a final wrap up we are doing a panel discuss with members of our bookkeeping team on our Podcast which we will post to the blog as well once we are done.

If you don’t have an accounting or tax advisor (or you need assistance with anything discussed), click here to book your complimentary strategy session with JETRO.

What is a Pass Through Entity?

Pass Through Entity - What is it and what does it mean?

Most businesses do not have to pay income taxes on the corporate level. Instead the profits from their business flows through (or passes through) to the owners of the company where it is eventually taxed.

Types of Pass Through Businesses

  • Sole Proprietor
  • Partnership
  • Single Member LLC
  • S Corporation

An example of a non pass through entity would be a C Corporation. In a C Corporation the company pays taxes on the profit of the business at the corporate level.

Basic Concept: If you have a pass through entity you have income and expenses related to the business that are reported on the business tax return (Schedule C, 1065, 1120S). The profit from those businesses are then reported on a personal return where the taxes are paid.

Here is the tax treatment for the various entity types:

Sole Proprietorship or Single Member LLC

File business information on a Schedule C on a personal tax return (Form 1040).

Partnership or Multi Member LLC

File business information on Form 1065 and then each partner will receive a K1 with their share of activity which will be used to report and pay taxes on the business activity on a personal tax return (Form 1040).

S Corporation

File business information on Form 1120S and then each owner will receive a K1 with their share of activity which will be used to report and pay taxes on the business activity on a personal tax return (Form 1040).

C Corporation (Not Pass Through Entity)

File business information on Form 1120 and then pay taxes at the corporate level.

Now you know what a pass-through entity is. Majority of small business owners in the US operate using a pass-through entity.

Check out our episode on the Small Business Tax Savings Podcast for more on this topic!

JETRO Goes Gusto Gold

JETRO Goes Gusto Gold

When JETRO started way back in 2013 we were looking for a modern, cloud based solution for the payroll side of our business.

We spent time researching and testing all the various options out there and just could not find a good fit that matched our model: modern, robust, and simple to use.

Luckily in 2014 we got introduced to Gusto and have not looked back since. Based on our research and experience, it is by far our preferred choice for payroll. Whether we are doing the payroll on behalf of clients or clients are handling it themselves we know they are in good hands when using Gusto.

As part of this journey we are proud to announce that we are now a Gusto Gold Partner!

Thank you Gusto for continuing to innovate and provide such an easy to use payroll solution for both JETRO and our incredible clients.

Want to learn more about Gusto? Reach out to us!

How should I structure my business with multiple owners?

How should I structure my business with multiple owners?

We often times get business owners that reach out to us that have multiple owners in their company, wondering what the best way is to structure their business.

In this specific article we are assuming an S Corp structure is desired prior to it reaching the owners personal tax return. If you don’t know what an S Corp is, we will dig into that in future post but in a nut shell it is a tax strategy to help limit the amount paid in self employment taxes.

With that assumption there are two main options we typically suggest. Note that this also assumes that all owners are going to be active within the business (not just silent investors).

Option 1

Setup company as an S Corporation with each owner as a shareholder in the business personally.

  • Advantages
    • One company, one tax return, one payroll account
    • Easier to setup and less maintenance
    • Cheaper
  • Disadvantages
    • Various owners cannot take advantage of tax strategies that help them but not other owners.
    • If you have multiple businesses you may need multiple S Corps.
    • Less Flexibility

Option 2

Parent company is a partnership with each owner having their own S Corp that owns their percentage in the partnership.

  • Advantages
    • Each partner can utilize tax strategies as they see fit (hire kids, business automobile, etc).
    • If they own multiple businesses their personal S Corp can hold the ownership in those and all business income will flow through their S Corp prior to reaching them.
  • Disadvantages
    • Multiple companies, multiple tax returns, multiple payroll accounts
    • More to setup and maintain
    • More expensive

 

With that being said, lets run through some scenarios.

Scenario 1: Two owners and one wants a Mercedes for his business vehicle and the other wants a Prius. In option 1, there could be some conflict because the price for these are vastly different and the person with a Prius does not get as much out of the tax strategy. However in option 2, it doesn’t matter because they can hold the vehicle ownership in their personal S Corp and do whatever they want with affecting the other owner.

Scenario 2: Two owners in which they are 100% active in the business with no other ventures. In option 2 they would have to pay for a tax return for the partnership and then two S Corps. They would also have to run two separate payrolls for each S Corp. Rather if they chose option 1 it would be one business return and one payroll which means it is more cost effective.

Generally if the owners have multiple businesses they participate in, we will suggest option 2 since they will want all income to pass through an S Corp anyways so they can avoid a portion of self employment taxes.

If the owners are on the same page as far as spending and tax strategies, we typically say option 1 is fine for them to help minimize costs and maintenance.

Either way, there is no one size fits all for every situation so be sure to discuss with a tax professional to ensure you get things right from the beginning.

Check out our episode on the Small Business Tax Savings Podcast for more on this topic!