Are You an S Corporation Stockholder? Are You Taking Reasonable Compensation in the Form of Wages?

Article Highlights:

  • S Corporation Compensation
  • Reasonable Compensation
  • Factors Determining Reasonableness
  • In the Spotlight
  • Sec. 199A Deduction

S corporation compensation requirements are often misunderstood and abused by owner-shareholders. An S corporation is a type of business structure in which the business does not pay income tax at the corporate level and instead distributes (passes through) the income, gains, losses, and deductions to the shareholders for inclusion on their income tax returns. If there are gains, these distributions are considered return on investment and therefore are not subject to self-employment taxes.

However, if stockholders also work in the business, they are supposed to take reasonable compensation for their services in the form of wages, and of course, wages are subject to FICA (Social Security and Medicare) and other payroll taxes. This is where some owner-shareholders err by not paying themselves a reasonable compensation for the services they provide, some out of unfamiliarity with the requirements and some purposely to avoid the payroll taxes.

The Internal Revenue Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes. S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.

If the S corporation does not pay its working stockholders a reasonable compensation for their services, then the IRS generally will treat a portion of the S corporation’s distributions as wages and impose Social Security taxes on the deemed wages.

There is no specific method for determining what constitutes reasonable compensation, and it is based upon facts and circumstances. Generally, it is an amount that unrelated employers would pay for comparable services under like circumstances and based upon the cost of living in the area where the business is located. The following are just some of the many factors that would be taken into account in making this determination:

  • Training and experience
  • Duties and responsibilities
  • Time and effort devoted to the business
  • Dividend history
  • Payments to non-shareholder employees
  • Timing and manner of paying bonuses to key people
  • What comparable businesses pay for similar servicesCompensation agreements
  • The use of a formula to determine compensation

The problem here, of course, is that it is easy for the IRS to list contributing factors used by the courts in determining reasonable compensation and leave it to the corporation to quantify these factors into a reasonable salary but still have the ability to challenge the selected amount later if an auditor, off the top of their head, decides the compensation is unreasonable.

The IRS has a long history of examining S corporation tax returns to ensure that reasonable compensation is being paid, particularly if no compensation is shown being paid to employee-stockholders.

Reasonable Compensation in the Spotlight – With the passage of tax reform, reasonable compensation will be in the spotlight because of the new deduction for 20% of pass-through income. This new Sec. 199A deduction is equal to 20% of qualified business income (QBI) and will figure intro the shareholder’s income tax return. The QBI for the stockholder of an S-corporation is the amount of net income passed through to the stockholder and designated as QBI on the K-1, but the stockholder may not include the reasonable compensation (wages) he or she was paid as QBI. Thus, wages paid to stockholders actually reduce the QBI because the S corporation deducts the wages as a business expense, therefore reducing the corporation’s net income and QBI. But that does not mean wages can be arbitrarily adjusted to maximize the Sec. 199A deduction.

IRC Sec. 199A Deduction – Here are some details about how the 199A deduction works and the impact of the reasonable compensation wages on the Sec. 199A deduction.

  • The S corporation’s employee-stockholder’s wages are NOT included in qualified business income (QBI) when computing the 199A deduction. Thus, the larger the wages, the smaller the K-1 flow-through income (QBI) and thus the smaller the 199A deduction, which is 20% of QBI. In this case, an S corporation would tend to pay the stockholder a smaller salary to maximize the flow-through income and, as a result, the 199A deduction.
  • If married taxpayers filing a joint return have taxable income that exceeds $315,000 ($157,500 for other filing statuses), the 199A deduction begins to be subject to a wage limitation, and once the taxable income for married taxpayers filing a joint return exceeds $415,000 ($207,500 for other filing statuses), the 199A deduction becomes the lesser of 20% of the QBI or the wage limitation. For these high-income taxpayers, an S corporation will tend to pay stockholders less wage income for them to benefit from the Sec. 199A deduction.
  • If an S corporation is a specified service trade or business, the Sec. 199A deduction phases out for married taxpayers filing a joint return with taxable income between $315,000 and $415,000 (between $157,500 and $207,500 for other filing statuses). And although the wage limitation is used in computing the phase out, once the taxpayer’s taxable income exceeds $415,000 ($207,500 for other filing statuses), the taxpayer will receive no benefit from the wage limitation and therefore would again want to minimize their reasonable compensation to minimize FICA taxes. Specified service trades or businesses (SSTBs) include those in the fields of health, law, accounting, actuarial science, performing arts, athletics, consulting, and financial services (for more information on what constitutes an SSTB, please call).

Of course, taxpayers cannot pick and choose a reasonable level of compensation to minimize taxes or maximize deductions. Therein lies a trap for taxpayers who do not consider the factors related to reasonable compensation. There are commercial firms that have the data necessary to determine reasonable compensation and specialize in doing so. These firms can be found by searching the Internet for “reasonable compensation.” Even the IRS has employed these firms to provide reasonable compensation data in tax court cases.

If you want additional information related to reasonable compensation, please give this office a call.

6 Common Small Business Accounting Problems That Are Killing Your Growth

If you’re a small business owner, you want your organization to do far more than survive: you want it to thrive! Unfortunately, to make sure that customers are happy and the lights stay on there are a lot of details that need attention, and some end up being overlooked. The intricacies of accounting are neither sexy nor fun, and most business owners don’t have the training or background that’s needed for this vital area of operations. To help make sure that you’re doing everything you can to maximize your profitability and fiscal responsibility, here’s a list of the six most common accounting problems small businesses encounter. By addressing each, you’ll go a long way toward assuring your business’ success and growth.

1. Not Using Accounting Software
There are a lot of benefits to using accounting software, and the most obvious of these is that if you try to do all of the necessary calculations by hand, you’re at risk for making a small mistake that can lead to a giant headache. There is a fantastic selection of software available — it may even feel overwhelming when you first begin doing the research – but if you take your time, read reviews and look for something that is designed to meet the needs of your particular type of business, you’re sure to end up satisfied. If you’re not sure what to look for, use this checklist of minimum requirements:

  • Sales tracking
  • Financial statements, cash flow statements and balance sheet
  • Generating Invoices
  • Contacts management and contact history tracking
  • Budget planning
  • Account to accept credit card payments
  • Inventory management
  • Payrolls
  • Taxation

2. Not Knowing How to Use the Software That You Have
It may seem funny, but the second most common mistake that small business owners make in terms of accounting is also about accounting software – it’s having the software in-house but not using it, not using it the right way, or not really knowing how to use it. Like the treadmill that sits in the corner of your bedroom and slowly becomes something to throw your clothes over, having invested in accounting software and then not actually using it (or using it the right way) is a reason for regret, and so much more beyond that. When you’re not using your software the right way, you leave yourself vulnerable to making accounting mistakes. More importantly, you end up taking far too much time on bookkeeping tasks that it could do for you quickly and efficiently. Most of the packages available come with tutorials, but if you need help, contact an accounting professional and ask them to run through bookkeeping basics with you so that you can use it to its best benefit.

3. Failing to Produce Monthly Financial Reports
A lot of small businesses tend to minimize the importance of financial reports, feeling that if they produce some snapshot every few months or even twice a year, it’s good enough. The truth is that if you have financial backers or are interested in getting additional investment in your business, having a monthly report is an essential tool for them, as well as a sign that you’re taking their investment seriously. More importantly, the more closely you monitor your company’s financial activities, the faster you can pick up on issues as they develop, including slow-paying clients, oversites in your accounts payable, and more.

4. Having the Numbers, But They’re Wrong
There are a lot of things that can lead to your financials being incorrect: it can be not using accounting software (or not using it correctly); failing to update data; inputting incorrect data; and more. Whatever the cause, the result is never good and can cause problems significant enough to close your business or scare investors away. Worse, it can leave you vulnerable to bad actors who can use the inaccuracy to perpetrate fraud.

5. Mixing Your Personal Accounts with Your Business Accounts
Even if you are operating a pass-through business, it is essential that you keep separate books, separate credit cards, and separate banking for your personal needs and your business needs. Failing to do this will make it nearly impossible to determine what expenses are deductible, what capital investments generate profit and more. Small oversights are more likely to occur in accounting for out-of-pocket expenses, and this generally leads to paying more in taxes than you need to. Worse, if you face an audit, it will lead to a nightmare of having to separate and justify accounting measures that have been taken.

6. Failure to Properly Manage Your Payroll
Payroll is one of the most complex areas of running a business. Not only do you want to make sure that you’re paying your employees appropriately, but you need to be sure that essential areas like payroll taxes and withholding are being done accurately. When in doubt, it makes sense to bring in outside professionals for assistance.

12 Common Tax Problems to Avoid

If you’re one of those who gets worked up over filing your tax return, there are specific steps you can take to help ease the struggle and avoid the most common tax issues that are reported each year.

Here are the top 12 tax issues, broken down into categories for business owners and individual taxpayers, and how everybody can minimize their impact this year.

If you own your own business:

1. Avoid penalties and fines by understanding the rules about deductions.

Though tax deductions are a great way to minimize taxes when they’re used the right way, they are frequently abused and overused. The whole point of deductions is to provide businesses the ability to eliminate taxes for items they purchased in the furtherance of their business. Though this includes capital expenditures, client gifts, and business travel, it does not mean that you can include expenses that you incur while talking about your business while you’re on vacation with your family. The IRS has published rules about how much of each expense can be deducted, what type of expense can be deducted and under what circumstance. If you include something that is questionable, you’re going to be asked to justify it, and if you can’t, you’re going to end up worse off than if you hadn’t made an attempt in the first place.

2. Failing to keep track of business expenses that can be deducted.

The flip side of people try to game the system by taking expenses to which they’re not entitled is people failing to deduct expenses that they could have because they’re not careful about keeping track. This frequently happens when people don’t have a credit card or account that is dedicated specifically to their business expenses, or when cash is used when traveling or attending business meetings. When you don’t deduct legitimate expenses, you’re cheating yourself out of tax savings, so start keeping all receipts, and talk to a tax professional so that you understand exactly what you can write off, and what you can’t.

Individual taxpayer problems:

3. Failing to choose a reputable professional tax preparer.

It’s nice of your cousin or next-door neighbor to offer to help, and you might save money by going to a storefront tax preparer that claims they will do the whole job quickly and at a low cost, but an awful lot of taxpayers end up in big trouble as a result of these types of offers. Whether the issue is incompetence or fraud, plenty of people are finding themselves facing penalties and fines or having their refund money stolen as a result of choosing the wrong tax preparer. Do your homework and be willing to spend the money to have your return prepared by a legitimate professional. The things to watch out for include promises of specific refund amounts prior to reviewing your documentation, fees that are based on the amount of your refund, and fly-by-night operations that appear right before tax season and then are gone on April 16th. If you do find a fraudulent tax preparer has victimized you, contact the IRS and attorney right away who will pursue justice and act as your advocate.

4. Filing after the deadline.

If you were late in filing last year, you had plenty of company – the IRS reported that almost 45 million taxpayers waited until April. But filing late is a mistake. You are likely to end up paying extra money in fines and penalties, and the later you are, the more likely you are to make errors that will make the entire process take longer and may lead to audits and delays. More importantly, if your lateness is a recurring theme and you still haven’t gotten in paperwork from previous years, it affects the accuracy of your current return and may impact your ability to get any refund or credit that you’re owed.

5. Failure to file a return at all.

Plenty of people disregard the tax laws and don’t submit a return. Many of them may not actually owe any taxes, while others reason that since they can’t afford to pay what they owe, they’re better off not submitting anything. This is absolutely wrong. If you are anticipating a problem with submitting the tax that you owe, you can file an installment agreement request that will help you set up a schedule of periodic payments instead of submitting the amount in full at tax time. This is a much better option than not filing, as even though you may have to pay some interest or penalties, they won’t be as punishing as the fees you’ll pay for failure to file a return. You can also choose to file an application for an automatic extension, which gives you more time to get the documentation together, if not the payments. Again, penalties and interest rates are much lower when you avail yourself of this option rather than failing to file.

6. Simple mathematical errors

Remember when you were a kid in math class and you’d get a quiz back with mistakes that you’d have spotted if you’d just double checked? Same is true with your taxes. Take the time to go back over your math before you sign on the dotted line or send your return in. It just takes a few extra minutes, and it can save a lot of time and aggravation. Alternatively, use a professional tax preparer and then you don’t have to worry about it at all.

7. Administrative errors

Just as you need to check that you’ve done your math computations correctly, you also need to take the time to take a second look at the forms that you’re filling out to make sure that you’ve filled in every box, used all the appropriate forms, and filled in your information correctly. You’d be amazed at how many people transpose the numbers of their social security number or whose handwriting is so bad that it can’t be read by the IRS and gets sent back. Take your time, be careful and do it right to save yourself a headache in the future. A few areas worth double-checking include:

  • Social Security Number
  • Bank Account Numbers and Routing Numbers
  • Signature and Date Lines

8. Not staying current with updates to tax laws.

Every year, there are new updates to the tax code that can make a big difference, and every year there are taxpayers who fail to take advantage of them because they simply weren’t aware that they existed. If you’re going to do your taxes yourself, take the time to stay up-to-date. Alternatively, you can work with a tax professional: part of their job is to know all the new laws and apply them to your best advantage.

9. Don’t use the wrong filing status.

Single. Head of Household. Married filing jointly. Married filing single. It can be very confusing to know which benefits you most, and choosing wrong can make an enormous difference. There are a lot of things that married couples are entitled to if they file jointly, and a lot of disadvantages to filing single. Take the time, do the math so that you know you’re doing the right thing.

10. Clutter may be bad, but you should hold on to your old tax returns.

No matter how much you try to keep it simple and purge old paperwork, your past tax return is one thing you really need to hold on to in case the IRS comes back and asks questions or you realize that you’re entitled to a refund if you file an amended return. Having the paperwork handy means you can give it to attorneys, mortgage brokers, accountants and the IRS itself in case they ask for it or if providing it would help your situation.

11. Learn about and take advantage of every potential deduction

Of all the painful mistakes that taxpayers make, overpaying is at the top of everybody’s list. What could be worse than giving the government more of your hard-earned money than you needed to? The best way to avoid this mistake is to go through the lists of possible deductions and write down every one you might be able to take, then see if you can use it.

12. Not using the right tax forms for your needs or status.

Though most people are familiar with the 1040 form, it’s not necessarily the right one for everyone. While the 1040 works for those who itemize or who own their own business, people who are W-2 employees without a lot of complicating factors may be better off using the 1040EZ form. Likewise, you need to make sure that there aren’t mistakes on any of the paperwork that you’re handing in, whether it’s your W-2 or information from any of your banks. Finally, many people are taking advantage of electronic filing to get their returns in on time and get their refunds more quickly, and if you’re doing that too, make sure that you’ve input the correct.

If there are errors on your W-2 Forms or other financial forms, make sure you address them sooner rather than later, or else the IRS will become involved. If you’re filing electronically, double check every digit of your information to avoid delays.

What if you can’t avoid a tax issue?

No matter how hard you try, at some point, you may find yourself facing one or more of the issues cited above (or something entirely different that we haven’t included). If that happens to you, contact us immediately for expert professional help.

10 Ways to Improve Profits in the Coming Year

In the U.S., the economy is thriving and expected to grow over the next few months. Businesses are expanding. The Federal Reserve has inched up interest rates, creating investment opportunities, and lenders are offering small business loans. All of this points to a promising outlook for the coming months. As a small business owner, this is the time to take a closer look at your profit and loss sheets to determine how you can make the most out of this current economy.

How Can You Increase Revenue and Profits in the Coming Year?

For most companies, increasing revenue and profit margins is a goal. Yet, there’s strong competition in most sectors. Here’s a look at ways you can boost your profit margins without having to invest heavily.

#1: Increase Pricing Marginally

Inflation is a key component of the current market. As the U.S. consumer increases confidence in spending, it becomes possible to increase prices. Re-evaluate your current price points. Are you getting enough from each sale to build profits?

#2: Don’t Overlook the Impact of Tariffs

The ongoing trade war with China has many business owners worried about cost. Plan now. Tariffs are impacting nearly all industries including construction, retail, restaurants, and manufacturing to name just a few. Work with your team to understand the impact on your business’s bottom line, such as the higher cost of goods, and build those costs into your prices.

#3: Get Rid of Tasks Not Adding Value to the Customer

Take a closer look at what you are spending on within your profit and loss. Is each one of these expenses directly contributing to your customers’ needs? Eliminate costs that do not contribute to customer value.

#4: Review Competitor Prices

Along with increasing your prices, take a closer look at what your competition is charging for services. There are two things to focus on here. If their prices are higher, why? Are they offering something better for their product or service that encourages a higher price point? Second, are your prices competitively aligned with theirs? If not, what can you do to offer something extra to your customer?

#5: Reduce Overstock

Carrying a significant amount of stock does not improve business operations and increases costs. It can drive up waste when product is lost or forgotten. It also hampers your company’s ability to keep inventory costs in line with your goals. Pair down stock.

#6: Find a Way to Increase the Value of Every Sale

Provide some last-minute addition your customer could buy to enhance their product or service. Ensure your sales team is speaking to each customer about this offer, right as they close the deal. If you sell cars, offer an add-on feature for a certain additional amount. If you sell professional services, determine if your customers could benefit from a monthly check-in or other add-on services.

#7: Expand Product or Services Lines With Care

Look for complimentary services and products that do not require a lot of investment to offer them to your customers. What additional products or revenue streams could enhance what you already provide? This may not require additional equipment or a large amount of inventory.

#8: Build Your Team’s Skillset

Beyond a doubt, in a sales-oriented business, your company cannot build revenue if your sales team misses their market. Invest in sales training for the modern audience. Focus on moving away from traditional methods toward more efficient and brand-building methods for sales.

#9: Get Your Numbers in Line Now

Hiring a team to help you explore your current profit margins is critical. However, bringing on a professional organization to help with managing your books is only effective if you apply the information and insights they provide to you. In other words, find a team you can sit down with and discuss opportunities you can apply right now.

#10: Build Your Customer Base

Use a variety of tools to help build your customer base. Complete a market analyses to better understand who your target customer is. Then, work to modernize your marketing efforts to attract that specific audience. When you do, you turn heads and capitalize on a new set of customers.

Building revenue and profits starts with knowing where you are specifically. Review your prices, financial accounts, and books with care. Then, look for small ways to reduce costs that don’t contribute to your profits and build up services, products, and prices for those that help your company to grow. Always have a focus on the bottom-line benefit of any investment you make.

Mitigating the Effects of Employee Burnout: What You Need to Know

Make absolutely no mistake about it: Not only is employee burnout very real, it’s probably costing your business a lot more money than you realize. It’s also not a problem that you’re necessarily going to be able to buy your way out of, either.

According to one recent study, a massive 70 percent of the workforce in the United States is not engaged with their current jobs in any type of meaningful way ― and employee burnout is a major contributing factor to this. As stated, if you think that this is because people don’t feel like they’re making enough money, the chances are very high that you’re wrong. The same study revealed that 89 percent of employers THINK that people leave jobs to get more money elsewhere, but in reality, that’s only actually true about 12 percent of the time. But perhaps the most damning statistic of all is the following: Collectively, disengaged employees cost organizations in the United States between $450 and $550 billion every year in terms of lost productivity alone.

So, once you’ve come to the realization that this is, in fact, a problem, you must then turn your attention toward taking advantage of any possible solution in front of you. The good news is that it is possible to mitigate the effects of employee burnout ― you just need to keep a few key things in mind.

Understand What Employee Burnout Looks Like

Not every employee is necessarily burned out ― even if they’re pulling long hours or giving everything to help you achieve your goals. But in an effort to avoid the major downsides of burnout on your business, you need to know more about how to spot it in its nascent stages. If an employee is burned out, they’re probably exhibiting one or even all of the following signs:

  • They’re exhausted, either physically or emotionally. The resources needed to cope with their work environment in these two areas are totally spent, and they tend to act accordingly. We’ve all been here, so you should know what it looks like.
  • They’re increasingly cynical. They know what they’re supposed to do and why it matters, but they’re less convinced that it really matters to THEM in the long run.
  • They’re growing more inefficient as time goes on. Burned-out employees tend to give up “trying” pretty quickly as a result of the cynical attitude outlined above, and the quality of the work they offer suffers as a result.

Put a Premium on the Mental Health of Your Employees

If you truly want to mitigate the effects of employee burnout, you need to focus not on correcting the problem but on trying to prevent it from happening in the first place.

This means placing a high priority on the mental health and wellness of all of your workers, something you can do in a few different ways.

Some experts recommend that you should hold walking meetings, for example. Instead of holding yet another meeting with your team in a stuffy boardroom with absolutely no natural lighting, get outside and take a walk around the block. You can still discuss all the same things (and thanks to cloud technology, you can likely refer to all of the same files on devices like smartphones and tablets), but the change of scenery will really make a big difference.

Along the same lines, don’t be afraid to encourage people to take mental health days ― especially during busy periods or the holiday season. Remember that a burned-out employee ultimately isn’t doing you any good anyway, so if they need to leave early one day or not come in at all, they’ll be at far more of an advantage than you are at a disadvantage in terms of lost productivity. Just knowing that you support their health and wellness like this will really go a long way toward mitigating this type of risk.

Likewise, you should always maintain an open door policy with your employees. If they feel like they need to come in and talk to you for any reason, good or bad, they should feel comfortable with their ability to do so. If they need something to thrive in their job every day, they shouldn’t be afraid to come ask for it because they should know you’ll work hard to get it. If they have a problem, they should feel willing to come talk to you to look for a solution. Again, the importance of this level of managerial support is something that you absolutely cannot overstate.

Everyone feels burned out every now and again ― this is not something you can avoid. But if you truly want to avoid letting employee burnout have a long-term negative effect on everything that you’ve already worked so hard to build, you need to recognize the problem and take steps now to do something about it. Oftentimes, success to that end is less the product of one big move and more about a series of smaller ones. Provided you follow tips like these every day, you’ll soon realize that a large portion of the hard work has already been done for you.

Rejoice – Business Meals Are Still Deductible

Article Highlights:

  • Ban on Deducting Entertainment Expenses
  • Business Meals
  • Mixed Entertainment and Meals
  • Substantiation Requirements
  • Disallowed Employee Business Expenses

If you are a business owner who is accustomed to treating clients to sporting events, golf getaways, concerts and the like, you were no doubt saddened by the part of the tax reform that passed last December that did away with the business-related deductions for entertainment, amusement or recreation expenses, beginning in 2018. You can still entertain your clients; you just can’t deduct the costs of doing so as a business expense.

While the ban on deducting business entertainment was quite clear in the revised law, a lingering question among tax experts has been whether the tax reform’s definition of entertainment also applied to business meals, such as when you take a customer or business contact to lunch. Some were saying yes, and others no. Either way, both sides recommended keeping the required receipts and documentation until the issue was clarified.

The IRS recently issued some very business-friendly guidance, pending the release of more detailed regulations. In a notice, the IRS has announced that taxpayers generally may continue to deduct 50 percent of the food and beverage expenses associated with operating their trade or business, including business meals, provided:

  1. The expense is an ordinary and necessary expense paid or incurred during the taxable year in carrying out any trade or business;
  2. The expense is not lavish or extravagant under the circumstances;
  3. The taxpayer, or an employee of the taxpayer, is present at the furnishing of the food or beverages;
  4. The food and beverages are provided to a current or potential business customer, client, consultant or similar business contact; and
  5. Food and beverages provided during or at an entertainment activity are purchased separately from the entertainment, or the cost of the food and beverages is stated separately from the cost of the entertainment on one or more bills, invoices or receipts.

The IRS notice also included the following interesting examples related to #5: The taxpayer invites a business contact to a baseball game. The tickets to the game are entertainment and not deductible. However, the taxpayer also purchased hot dogs and a beverage for himself and the business contact. Because the food and drinks were purchased separately, they are not disallowed as entertainment and are deductible if they otherwise qualify as an ordinary and necessary business expense. Had the ticket price included the hot dogs and beverages, they would be treated as non-deductible entertainment. If the ticket price separately stated the ticket price and the food and beverage price, then the food and beverage portion would not be disallowed as entertainment.

Of course, the substantiation requirements still apply. You must be able to establish the amount spent, the time and place, the business purpose and the business relationship and names of the individuals involved. You should keep a diary, an account book, digital files or similar records with this information and record the details within a short time of incurring the expenses. If the meal expense is $75 or more, documentary proof (receipts, etc.) is also required.

If you are an employee, starting in tax year 2018, you will not be able to deduct your unreimbursed employee business expenses, including the cost of client meals. These expenses have been deductible as miscellaneous itemized deductions when you itemized deductions and when your total deductions in that category exceeded 2% of your adjusted gross income. Under the tax reform, this category of deductions is not deductible for years 2018 through 2025. So, unfortunately, the IRS’s expansive definition of meal expenses will not benefit you.

If you have questions related to business meals, substantiation or the ban on entertainment expenses, please give this office a call.

The Key Steps to Take BEFORE You Start a New Business

Very few people think that starting a new business is easy. But at the same time, there are few first-time entrepreneurs who realize just how involved things are from the moment you start trying to bring that idea that previously only existed in your head into the real world.

There’s a massive amount of commitment required, even before your business technically exists at all. This is okay, because as the old saying goes, “anything worth doing is worth doing right.”

In fact, there are a number of key steps that you need to take BEFORE you’ve even started the business of your dreams that you’ll absolutely want to pay close attention to moving forward.

Identify the “Why” of It All

First thing’s first: Before you do anything else, you need to determine why you feel so compelled to start this particular business at this particular time.

Is it just because you think you have a great, sure-fire idea that is going to generate a lot of money? If so, you may want to take a step back… you’ll likely be disappointed. But if it’s because this will allow you to genuinely do something you love, and something that you think will make an impact on the lives of a lot of people, then, by all means, push ahead.

Identify the NEED

Next, you need to verify that this idea of yours is actually a viable one in the first place; essentially, you have to confirm that there is a genuine need in the marketplace for a product or service like the one you want to create.

DO NOT allow yourself to become “a solution in search of a problem.” Make sure that people are asking for a business like yours and that need is currently going unfulfilled.

DON’T Quit Your Day Job

Building a successful business is not something that happens overnight. This often takes years of planning and hard work, not to mention many mistakes along the way.

All of this is to say that if your ability to quit your day job and focus on your new business full time depends on an instant success… don’t quit your day job just yet.

DON’T Neglect Your Family

Yes, starting a business is something that requires a huge amount of your time. Yes, you need to devote every ounce of space in your brain and every free moment to this goal. But do not, under any circumstances, let that come at the expense of your loved ones and those around you.

You’re going to need quite a bit of support to get your new business up and running. If you neglect your family now, you’re not going to have that support later.

The Art of Writing a Business Plan

At this point, you can start working on making your vision a reality. This part of the journey always begins in the same basic way: writing a realistic, actionable business plan that will guide your every move in the future.

With a business plan, you really do need to be as specific as humanly possible. You know where you’re starting, and you know where you want to end up. The job of a business plan is to connect those dots by way of a series of smaller, logical and achievable steps. It’s essentially the roadmap you’ll use to shine a light through the darkness, guaranteeing that you’re always moving in the right direction (and that this direction is forward).

The Entrepreneur’s Bet

As you write your business plan, you’ll also have to make what is often referred to as “The Entrepreneur’s Bet.” Essentially, you need to figure out how much money a business like yours needs to make in order to become profitable.

You also need to acknowledge that, once again, your business is very unlikely to be successful enough right away to have this bet pay off in the short term. A lot of new businesses are operating at a loss at first — that’s okay. But this is yet another step that confirms the path you’re on is actually viable and it’s one that you absolutely do not want to skip.

The Myth of the “One Size Fits All” Approach

At this point, it’s also important to acknowledge that there really is no one “right way” to start a business. The choices you have to make will be influenced by a wide range of different factors, many of which are unique to your industry, your business plan and even the vision that you’re starting with.

Case in point: You need to review all local, state and federal regulations pertaining to what you’re trying to accomplish. Different places have different laws, and ignorance is not an excuse for breaking them. Factors like how to become compliant, what standards a product has to meet and more will all be influenced by these regulations, and they will impact a lot of the steps on your business plan as well.

It’s Time to Start Thinking About Technology

Once this foundation is all in place, it’s time to start thinking about the tools you’ll need to bring your new business into the world. These days, that involves a lot more technology than people often realize.

This is another one of those steps that will obviously be impacted by the type of business you’re starting. A local brick-and-mortar retail store will obviously have different technological needs (point of sale systems, inventory management equipment, etc.) than an online marketing agency (graphic design software, collaboration tools, etc.).

But when built properly, your technology strategy and your business strategy are essentially one and the same. They feed into one another, and your IT helps generate the momentum you need to continue to grow and expand while remaining agile as well. It’s far too important to neglect.

Choosing the Right Business Entity

This is another important step you don’t want to skip because it dictates things like taxes, paperwork, liability and other legal elements of your business.

One of the most common types of business entities is the limited liability structure, or LLC. This is because it provides you with the level of flexibility you need right now, coupled with the protection you’ll need from a personal liability standpoint.

But that isn’t a guarantee that this is right for you. Other structures like sole proprietorships, partnerships, S corporations and C corporations all have their fair share of advantages and disadvantages. You need to pick the right one today or you’ll open yourself up to a world of problems tomorrow.

Finding the Help You Need (and You WILL Need It)

Finally, as your journey toward true entrepreneurship is about to begin in earnest, you need to understand two of the core pillars of successful business ownership:

  1. You do not know everything, even if you think you do.
  2. You cannot do it all alone, even if you think you can.

The difference between failed and successful business owners often comes down to the acknowledgment of these two points.

Rather than do a poor job at a business task for which you don’t have the skills, don’t be afraid to hire someone who does have those skills. Rather than guess at answers to questions, find the right advisors and mentors to guide you. Reach out and find the people who are willing to assist you and don’t be afraid to share your vision with them.

You WILL need help and there are people who are absolutely willing to stand by your side. You just have to want to look for them.

In the End

It’s fair to say that starting a new business is harder than you probably thought it was going to be, especially when you consider the sheer amount of time you’ll need to devote to the steps outlined above. But provided that you have a realistic vision and a passion that cannot be extinguished, success is no longer a question of “if” but “when.”

The stakes are high and the risk is higher, but the rewards are even greater if you persevere. Never let anyone tell you otherwise.

Do You Own a Specified Service Trade or Business? If So, Your 20% Flow-Through Tax Deduction May Be Limited

Article Highlights:

  • 20% Flow-Through Deduction
  • Qualified Trade or Business
  • Specified Service Trade or Business
  • Deduction Table
  • Listing of Service Businesses

As part of its recent tax reform, Congress included a new 20% deduction of pass-through income for trades or businesses other than C-corporations. This pass-through income is referred to as qualified business income (QBI); for trades or businesses, it generally includes bottom-line profits, and for S-corporations and partnerships, it includes K-1 flow-through income. This new law was added as tax code section 199A, so the deduction is often referred to as the 199A deduction.

Congress added this deduction to benefit sole proprietors, partners, and S-corporation shareholders (among others); the goal is to allow for benefits equivalent to the substantial tax-rate cut that the same reform provided to C-corporations. However, this new deduction is not applied uniformly to all types of trades and businesses, for which there are two categories:

  • qualified trades or businesses (QTBs) and
  • specified service trades or businesses (SSTBs).

This deduction is limited by the taxpayer’s filing status and 1040 taxable income, and it differs depending on whether the business is a QTB or a SSTB. Although the main purposes of this article are to define SSTBs and to describe how they are taxed differently from QTBs, if one is to understand why an SSTB may not qualify for the deduction, whereas a QTB might qualify, it is necessary to first understand the basic differences between the deductions for SSTBs and QTBs.

Apparently, Congress considered the income from service businesses to be akin to wages and didn’t want taxpayers who provide services to have the benefit of the 20% deduction instead of paying taxes on that income as ordinary wages. This change was primarily aimed at deterring high-income people from becoming independent contractors or setting up pass-through businesses so that they could turn their wages into business income and get the 20% deduction. The result is a phase-out of the deduction for high-income taxpayers who have income from SSTBs.

The table below provides an overview of the tax treatment for each type of business. As you will note, the SSTB deduction phases out for higher levels of 1040 taxable income, but the QTB deduction does not. This type of phase-out is called a wage limitation.

Example of How to Use the Table: Two married people who are filing jointly have 1040 taxable income (before the 199A deduction) of $469,000; they also have a SSTB. They would first select the box with their filing status (“Married Filing a Joint Return”), then move to the right to the correct range of 1040 taxable income (which is the adjusted gross income after removing either the standard deduction or the itemized deductions; in this case, “Greater than $415,000”), and finally follow that column down to the cell aligned with the correct type of business (“SSTB”). In this case, the trade or business does not qualify for the 199A deduction.

Taxpayer’s Filing Status

Taxable Income
(Before the 199A deduction)

Married Filing a Joint Return
Less Than $315,000
Between $315,000 and $415,000

Greater than $415,000

Other filing Statuses
Less Than $157,500
Between $157,500 and $207,500

Greater than $207,500

Type of Business
The 199A Deduction
SSTB
20% of QBI
Deduction phased out
No deduction allowed
QTB
20% of QBI
Wage limitation phased in
Deduction equal to the lesser of 20% of QBI or the wage limitation

Specified Service Trades or Businesses (SSTBs)

The IRS describes SSTBs as being in the following fields:

  • Health – The health category includes the provision of services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and similar health care professionals who provide medical services directly to patients. However, this excludes the provision of services that are not directly related to a medical field, even when those services purportedly relate to the health of the service recipient. For example, this category excludes the operation of health clubs or spas that provide physical exercise or conditioning; health-related payment processing; or the research, testing, manufacture, and/or sales of pharmaceuticals or medical devices.
  • Law – The law category refers to the provision of services by lawyers, paralegals, legal arbitrators, mediators, and similar professionals in their capacities as such. The category excludes the provision of services that do not require skills unique to the field of law, such as the printing, delivery, and stenography services provided to lawyers.
  • Accounting – The accounting category includes the provision of services by accountants, enrolled agents, tax-return preparers, financial auditors, and similar professionals in their capacities as such. This category is not limited to services that require state licensure as a certified public accountant. This category also excludes payment processing and billing analysis.
  • Actuarial Science – The actuarial science category refers to the provision of services by actuaries and similar professionals in their capacities as such. This category only includes the services provided by analysts, economists, mathematicians, and statisticians if they are engaged in analyzing or assessing financial costs due to risk or uncertainty.
  • Performing Arts – The performing arts category includes the performance of services by individuals who participate in the creation of the performing arts, including actors, singers, musicians, entertainers, directors, and similar professionals in their capacities as such. It excludes services that do not require skills that are unique to the creation of performing arts, such as the maintenance and operation of equipment or facilities. Similarly, the dissemination of video or audio of performing-arts events to the public is not considered to be a service in the performing arts.
  • Athletics – The athletics category refers to the performance of services by individuals who participate in athletic competitions, including athletes, coaches, and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards, and racing. This category excludes the provision of services that do not require skills that are unique to athletic competition, such as the maintenance and operation of equipment or facilities for use in athletic events. It also excludes the provision of services by persons who disseminate video or audio of athletic events to the public.
  • Consulting – The consulting category refers to the provision of professional advice and counsel to clients to assist them in achieving goals and solving problems. Consulting professionals include lobbyists and similar professionals, but this category focuses on their capacities as such and excludes the minor consulting that accompanies the sale of a product. A trade or businesses cannot be an SSTP if less than 10% of its gross receipts are from consulting (or 5% if the company’s gross receipts are greater than $25 million).
  • Financial services – The category of financial services applies to services that are typically performed by financial advisors and investment bankers, including the following financial services: managing wealth; advising clients with respect to their finances; developing retirement and wealth-transition plans; providing advisory and other services regarding valuations, mergers, acquisitions, dispositions, and restructurings (including in title 11 bankruptcies and similar cases); and raising financial capital through underwriting or by acting as a client’s agent in the issuance of securities. This includes the services provided by financial advisors, investment bankers, wealth planners, retirement advisors, and similar professionals but excludes banking services such as deposit-taking or loan-making.
  • Brokerage Services – The brokerage services category includes services in which a person arranges transactions between a buyer and a seller with respect to securities and in exchange for a commission or fee. This includes services provided by stock brokers and similar professionals but excludes services provided by real estate or insurance agents and brokers.
  • Reputation or Skill – The original legislation’s list of SSTBs included trades or businesses for which the principal asset was the reputation or skill of one or more of employees or owners. However, it was unclear if this meant, for example, that a self-employed plumber who provided his skill to the business would be eligible for the 199A deduction. The taxpayer-friendly interpretation of these tax regulations has generally defined “reputation and skill” to mean:(1) The receipt of income in exchange for endorsing products or services for which the individual provides endorsement services;

    (2) The receipt of licensing income in exchange for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbol associated with that individual’s identity; or

    (3) The receipt of appearance fees or income (including fees or income paid to reality performers who appear as themselves on television, social media, or other forums; radio, television, and other media hosts; and video game players).

The amount of pass-through deduction that is ultimately available due to an SSTB is entirely dependent upon the taxpayer’s 1040 taxable income. Thus, in some cases, pension contributions and the expensing of business assets can lower a taxpayer’s taxable income enough that he or she benefits from an increase in the pass-through deduction. In this scenario, married couples who are not living in community-property states could benefit from filing separately rather than jointly.

If you have questions related to whether your business qualifies for this new deduction, whether it is classified as an SSTB, or how SSTB income fits into your overall tax picture, please give this office a call.

Are You Prepared for a Disaster?

Article Highlights:

  • Business Owners
  • Family and Home
  • Records
  • Disaster Scams
  • Self-help Publications
  • Government Assistance

This year’s wildfires, record rains, flooding, tornadoes, hurricanes and potential for earthquakes should all act as reminders that you should be prepared for a disaster. Sure, it will take some effort on your part and you may never be affected by a disaster, but if you are, you will sure wish you had been prepared. It can become a nightmare, whether it impacts you personally or your business.

Business Owners – If you are a business owner, unexpected events can have a devastating effect on your business. You need to be protected from any number of natural and unnatural events, such as fire, computer failure and illness or the loss of key staff, all of which can make it difficult or even impossible to continue day-to-day operations.

Good planning can help you take steps to minimize the impact of a disaster and protect your business. The following recommendations can help your business cope with an unforeseen calamity.

By identifying possible disasters that may affect you and your business, you may be able to minimize the risks and losses that might occur. A well-thought-out business continuity plan will identify an action plan, safety concerns, applicable computer back-ups and alternative operational headquarters. It will also provide a road map back to normal activities by highlighting the points of contact for insurance and emergency relief way ahead of time.

How will you escape? Where will you meet up? How will you communicate? Map out and practice escape routes from your building. Familiarize yourself with the local authorities and emergency radio signals announced at the time of a disaster. What happens if you survive the disaster but your biggest supplier does not? Develop backup vendors and relationships ahead of time. Don’t forget that many employees will have families to care for and that their homes may be damaged or destroyed by the disaster. Have you stockpiled water, batteries, first aid kits and food in case emergency services are delayed?

As many realize after the fact, they are not insured for many natural disasters under their existing business policy. You may need to add or increase coverage, if it is available. Check with your carrier for details on your coverage.

Different types of businesses have different computer system needs, and those systems need to be backed up in case an event damages or causes the loss of the business’s computer capabilities. Backups are easy with the current online technology. Many businesses now have outside vendors that host and back up their computer systems for them. Inquire about whether they have redundant backup systems and request information on their emergency plans. In fact, in many cases, businesses now have their entire computer systems and data online, and these backups function from anywhere, from any computer.

If the disaster is only temporary and shuts down the electrical grid to your business, a generator may be a sound investment. The generator can power your computer system, equipment, refrigerators and other crucial items.

Family and Home – Just like a business, your family needs to have an emergency plan. They may be in different locations, such as school, work and home, when a disaster strikes. You need to have plans in place for where to meet if separated and a pre-planned evacuation route or action plan for unexpected disasters. The pre-planned evacuation route should avoid areas that can flood or are dangerous. It is good practice to never let the fuel level in your car(s) get below half-full, or let your electric car be less than half-charged, because the area may lose power, and gas stations may also be damaged by the disaster or run out of fuel.

While many people these days use credit or debit cards or other electronic payment methods in lieu of cash for their purchases, it’s a good idea to have some cash on hand for times when a disaster causes the electricity to be out for an extended period of time. Without power, vendors won’t be able to process non-cash payments.

Is your insurance coverage appropriate? Do you have supplies of batteries, flashlights, water, food, medications and first aid supplies in case of an emergency? And don’t forget to consider the needs of your pets during and after an emergency.

Records – We now live in a digital world, and if you are computer savvy, an easy way to keep your records out of harm’s way is to store digital copies of the documents on a remote server (i.e., in the cloud). It may cost a few bucks a month, but the digital files will be there when you need them, regardless of what happens to your home or business location. If you aren’t a fan of cloud storage, you should maintain an up-to-date backup of your computer files on an external hard drive or thumb drive(s), preferably with a copy stored in a secure location away from your home or office that is not likely to be affected by the same disaster.

Most financial institutions these days provide all of their documents digitally, and you can store those documents on your remote server or even retrieve them from the financial institutions’ websites. However, before relying on the financial institutions, make sure they retain your records for long enough to meet your needs.

For example, you generally need to keep individual tax records for at least 3 years after the tax return’s due date for that tax year or the date when you filed the return, if it was filed after the due date. For example, your 2017 return was due April 17, 2018. If you filed it on or before April 17, the statute of limitations for the 2017 return would not run out until April 15, 2021. So, you would have to keep the records for the 2017 tax return until then. (The statute of limitations runs for 4 years for some states, and some records need to be kept longer for both federal and state purposes.) If some of your files are not already available digitally, you can always scan the originals to create digital copies.

Another very important thing to everyone is family photos. Modern-day pictures are digital, so you can save them on a remote server, or many photo services will save them online for you. For the older important ones, you can scan them or take digital pictures of them with your camera.

Another important document to have is a list of your home’s and business facility’s contents for insurance purposes. The quick and easy way is to take a video or pictures throughout the house or business showing the furnishings and equipment. A better method is to take the pictures or video and back them up with a detailed list of the items in each room.

Disaster Scams – Whenever there is a disaster, lowlifes show up and try to scam generous individuals out of money intended to go to victims of the disaster. Don’t you be another victim of the disaster – watch out for scammers claiming to represent charitable organizations, who will pocket the donations for themselves instead. Besides fraudsters soliciting on behalf of bogus charities, some so-called charities aren’t entirely honest about how they use contributions.

You may receive phone calls, emails, snail mail or appeals on social networking sites for donations to help the victims of the most recent disaster. Some of these appeals may come from fraudsters and not legitimate charities. Unfortunately, this happens often after natural disasters such as earthquakes and floods.

So before writing a check or giving your credit card number to a charity that you aren’t familiar with, check them out so you can be assured that your donation will end up in the right hands. Follow these tips to make sure that your charitable contributions will actually go to the cause you are supporting:

  • Donate to charities that you know and trust. Be alert for charities that seem to have sprung up overnight in connection with current events.
  • Ask if a caller is a paid fundraiser, who he/she works for, and what percentages of your donation will go to the charity and to the fundraiser. If you don’t get clear answers – or if you don’t like the answers you get – then consider donating to a different organization.
  • Don’t give out personal or financial information – such as your credit card or bank account number – unless you know for sure that the charity is reputable.
  • Never send cash. You can’t be sure that the organization will receive your donation, and you won’t have a record for tax purposes.
  • Never wire money to someone who claims to be from a charity. Scammers often request donations to be wired because wiring money is like sending cash: once you send it, you can’t get it back.
  • If a donation request comes from a charity that claims to be helping a local community group (for example, police or firefighters), ask members of that group if they have heard of the charity and if it is actually providing financial support.
  • Check out the charity’s reputation online using Charity Navigator, Charity Watch or other online watchdogs.

Self-Help Publications:

Recovering and Government Assistance

The following government agencies may provide assistance:

  • Small Business Administration (SBA) – The SBA provides low-interest loans to businesses, homeowners and renters who are victims of a disaster. It even provides loans to replace or repair damaged or destroyed clothing, appliances, furnishings and automobiles. For more information, visit its website at: www.sba.gov.
  • Federal Emergency Management Agency (FEMA) – Disaster assistance is provided in the form of money or direct assistance to individuals, families and businesses in an area whose property has been damaged or destroyed and whose losses are not covered by insurance. It is meant to help with critical expenses that cannot be covered in other ways. For more information, visit its website at: www.fema.gov.

Since many disasters strike without warning, being prepared can help your business and family to recover more quickly from a catastrophic emergency. Take the necessary steps to ensure that both you and your business are well protected.

Please give this office a call if you have questions or if we can provide any other assistance.

Client communications protected by Sec. 7525

Sec. 7525 provides a limited privilege to communications between a federally authorized tax practitioner and a taxpayer to the extent the communication would be considered privileged if it were between an attorney and a taxpayer. For this privilege to apply, the communication must be for the purpose of securing tax advice with an expectation of confidentiality. This privilege is limited to noncriminal matters before the IRS or a federal court and generally does not extend to communications regarding tax shelters. Similar to the attorney-client privilege, if the communications are disclosed to others, the privilege can be waived.

FEDERALLY AUTHORIZED TAX PRACTITIONER

A federally authorized tax practitioner is any individual authorized under federal law to practice before the IRS and can include professionals such as CPAs, attorneys, enrolled agents, enrolled actuaries, and other types of professionals (Sec. 7525(a)(3)(A) and Section 10.3 of Circular 230, Regulations Governing Practice Before the Internal Revenue Service (31 C.F.R. Part 10)). A tax practitioner may also include in-house practitioners who are eligible to practice under Circular 230 (Eaton Corp., No. 12 MC 24 (N.D. Ohio 8/15/12)).

CLIENT-TAXPAYER

For the Sec. 7525 privilege to apply, the person asserting the privilege must be a client or be in the process of becoming a client of the tax practitioner. The Sec. 7525 privilege does not apply to communications between the tax practitioner and other parties outside the professional client relationship.

Case law provides guidance on who, in the corporate context, constitutes the “client” for purposes of the attorney-client privilege (and, by extension, the Sec. 7525 privilege). For example, in Upjohn Co., 449 U.S. 383 (1981), the Supreme Court held that the attorney-client privilege applies to communications by any corporate employee, including lower- and middle-level employees and in-house counsel, where the communication is for the purpose of the corporation’s obtaining legal advice. This holding specifically rejected the lower court’s ruling limiting the privilege to individuals empowered to act on behalf of the corporation (the control group). The Supreme Court declined to establish a specific test but rather held that each case must be evaluated individually to determine whether the purpose of the communication would enable the legal counsel to provide well-reasoned advice to the client.

Other cases have expanded the underlying rationale of Upjohn to include former corporate employees and employees of domestic and foreign subsidiaries (see In re Coordinated Pretrial Proceedings in Petroleum Products Antitrust Litigation, 658 F. 2d 1355 (9th Cir. 1981), cert. denied, 455 U.S. 990 (1982); Admirals Ins. Co., 881 F.2d 1486 (9th Cir. 1989); In re Teleglobe Communications Corp., 493 F.3d 345 (3d Cir. 2007); and Mobil Corp., 149 F.R.D. 533 (N.D. Tex. 1993)). These cases support a determination that communications between a tax practitioner and employees beyond the control group, including those of non-U.S. entities, may be subject to the Sec. 7525 privilege, as long as the employees are acting under the direction of the corporate control group concerning matters within the scope of their corporate duties in order for the corporate taxpayer to obtain tax advice from the tax practitioner.

For a detailed discussion of the issues in this area, see “Tax Practice Responsibilities: The Sec. 7525 Privilege Relating to Taxpayer Communications” in the August 2018 issue of The Tax Adviser.

— Nicholas Nebolsine, CPA