Observations: Corporation vs. Limited Liability Company (LLC)

A regular question we hear is, “Should I have an LLC or a Corporation for my business?” That depends on your organizational goals, tax strategy and how you plan to protect yourself from potential liabilities. The following information is incomplete and general, and should not be relied upon for making any decisions. I am touching on just a few matters relating to taxation. If you wish to create a business entity you need to have a meeting with your CPA as a first step.

A corporation is a legal entity that is separate and distinct from its owners. The states that allow for their charter also consider them to be an individual person, with the same rights to enter into contracts, own assets, have bank accounts and loans, sue and be sued separately from its owners, and have a work force. Ownership percentage is determined by the number of shares authorized and issued.

A limited liability company (LLC) is a form of partnership that combines the limited liability of a corporation with the pass-through tax rates of a partnership. Partnerships are pass-through entities because the profits are not taxed on the partnership tax return, but are passed through to the partners’ individual tax returns where the profits are subject to individual tax rates, as well as Social Security and Medicare taxes.

If you form an LLC by yourself and have no partner, the partnership is considered by the IRS to be disregarded for tax purposes, hence the term “Disregarded entity.” By disregarding the partnership entity, you are not required to file a partnership tax return. You do however retain the legal entity and its protection of the owner from the company’s liabilities. You would report your business income and expenses on the Schedule C of your personal income tax return. Schedule C profits are subject to Social Security and Medicare taxes; called self-employment taxes.

Unlike a Sole Proprietor who also reports on Schedule C, the disregarded entity LLC is legally separate from its owner. If the LLC is sued, the owner is generally not liable unless personally negligent. Contrast that with a sole proprietor who has all of her assets, personal and business, at risk. Of course our sole proprietor can, and should, buy liability insurance.

Once a corporation or LLC are formed at the state level, it is up to the owners to make an election with the IRS as to how those entities will be taxed in future years. If you form a corporation and fail to make an election with the IRS, you will have a C corporation on your hands.

A C corporation is a clearly separate legal entity that requires a unique understanding to properly manage. The owners are subject to double-taxation because corporate income taxes are paid before any profit is distributed. If the owners receive a dividend, those are taxed again on the personal tax returns of the recipients. That is double taxation. Smaller C corporation owners usually take a salary to extract value from their corporations, but if they fail to take a bonus at the end of the year and leave profits in the corporation, the entity will pay corporate income tax. You need to know what you are doing, or have help from your accountant, to effectively manage a C corporation, or Professional Service Corporation.

If you elect to classify your corporation under subchapter S, your profits will flow onto your personal tax return and will only be subject to income taxes. This is very different from distributions from a partnership where distributions are subject to self-employment taxes in addition to income taxes.

An LLC with multiple owners can be taxed as a partnership. However today we see most small LLC’s electing to be taxed as a corporation, and making the subchapter S election to retain the pass-through nature of the profits that also avoids the self-employment taxes.

Wages are subject to Income tax, Social Security tax and Medicare tax. S profits, which come after payroll expenses, are extracted as a distribution, and are subject to income tax only. Social Security and Medicare taxes (called FICA) are 15.3%; with the business paying half and the employee paying the other half. When the owner is also the employee, that one person ultimately pays the entire 15.3%. Consider that on a $100,000 salary, the FICA will be $15,300. If your business lasts 20 years and you always take the same salary, the FICA adds up to a substantial $306,000.

Any owner of an S entity is automatically considered, by law, to be an employee of that business. They are further required to take a reasonable wage or salary for their position. What is reasonable? The simplest answer is whatever you would have to pay somebody else to do your job. To save money, some S owners only take a token salary and allow most of the fruits of their labors to flow onto their tax returns as distributions, escaping a portion of the SS and MED taxes. The explosive growth of the subchapter S entity over the last 20 years is no accident. The IRS is very aware of this behavior and does have the power to step in and convert distributions of profits into wages when they catch somebody, and the penalties and interest can be substantial.

If you own a business or are thinking about starting one, the requirements and pitfalls are so numerous that to rely on anyone but a CPA or Attorney to help with your organizational decisions will result in mistakes that will cost a lot more than the professional fees; which by the way are deductible to the business. The penalties for your mistakes are never deductible.

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Storm Victims E-file Deadline NOV 18

Storm victims have until Saturday, November 18, 2017 to e-file 2016 tax returns. After November 18 all tax returns will have to be mailed.

The IRS will be shutting down it’s e-file system for annual update after November 18.

Storm victims continue to have January 31, 2018 as their final deadline for filing 2016 tax returns.

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The Cohan Rule

This is a common law rule that allows a taxpayer to use a reasonable estimate of business expenses based on some factual foundation, when they are unable to produce records of said expenses. The legal citation is Cohan vs. Commissioner, 39 F. 2d 540 (2d Cir. 1930).  

George M. Cohan was an American entertainer who is famous for his stage work, and standard songs like “Over There,”  “Give My Regards to Broadway,” and “Yankee Doodle Boy.” George was one of the first lucky souls to get an IRS audit, and because he did not keep records the auditors disallowed fifty-five thousand dollars of business expenses.

In his work George had to travel all over the country – sometimes with his attorney; take trains, cabs, pay for hotels, eat in restaurants, leave tips and any other legitimate expenses that an entertainer and his entourage would incur when on the road. Of course claims of luxurious business expenses continue to catch the attention of the IRS to this day.

The IRS took the hard position that the claims had to follow regulation and be fully documented. George took the IRS to court, and convinced the court of the necessity of his expenses based on other credible evidence. The court agreed but only to the extent of forcing the IRS to consider a reasonable estimate, and not the exact numbers he originally claimed.

“The Board refused to allow him any part of this, on the ground that it was impossible to tell how much he had in fact spent, in the absence of any items of details. The question is how far this refusal is justified in view of the finding that he had spent much and that the sums were allowable expenses. Absolute certainty in such matters is usually impossible and is not necessary; the Board should make as close an approximation as it can,” Circuit Court Judge Learned Hand. The complete decision can be found here: http://pegasus.cc.ucf.edu/~bandy/cohan.htm

The Cohan rule does afford a taxpayer the ability to present a logical estimate of a reasonable expense based on fact, but the final decision is always discretionary. The taxpayer, because she used an estimate of her business expenses, does not automatically get to keep the approximated expense and resulting tax, because Judge Hand decided that the Board should at least afford “For some allowance;” not necessarily all of it.

If you plan to present an estimated expense to the IRS during an audit, be prepared to compromise because is has been our experience that the IRS will start with the position that your number is too high, and it is up to you to prove that it is not. The technology we use in the modern business environment makes producing expense records easier, and you should use third-party proof whenever possible. But if you do have to rely on an estimate make sure you can support it before you put it on your tax return. If the IRS questions your estimated expense, raise the Cohan rule and explain your logic. In George’s case, how could he have visited all of those cities and made his money without incurring some expenses? Your licensed tax professional will know what to do.

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Tax Credits for Qualified Plug-In Electric Motor Vehicles

You can get a Federal tax credit of up to $7,500 when you buy a Qualifying Vehicle. It must be an electrically powered motor vehicle for street use, no golf carts. The weight must be less than 14,000 pounds. It has to be propelled primarily by an electric motor drawing power from a battery that has a capacity of at least 4 kw hours, and can be recharged from an external electrical source.

The credit is the sum of $2,500 plus $417 for each kw hour of capacity in excess of 5 kw hours, but not in excess of $5,000; making the maximum Federal credit $7,500. The credit begins to phase-out in the second quarter that a manufacturer sells 200,000 qualifying vehicles after 2009. Electric vehicles have not sold well in the US, so many continue to be eligible for the credit.

If you are interested in the credit to offset the higher cost of the electric vehicle, be sure to contact your licensed tax professional to help with planning before you make your purchase. Your tax professional can help determine the effect on your taxes, that your choice is a qualified vehicle, and whether or not your State offers a similar credit.

Here is a general list of Qualified Vehicles; your specific vehicle and the credit you receive may be different:

Audi A3 e-tron (2016-2017), $4,502

Audi A3 e-tron ultra (2016), $4,502

BMW i3 Sedan with Ranger Extender (2014-2017), $7,500

BMW i3 Sedan (2014-2017), $7,500

BMW i8 (2014-2017), $3,793

BMW X5 xDrive40e (2016-2018), $4,668

BMW 330e (2016-2018), $4,001

BMW i3 (60Ah) Sedan (2017), $7,500

BMW 740e (2017), $4,668

BMW 530e (2018), $4,668

BMW 530e xDrive (2018), $4,668

BMW 740e xDrive (2018), $4,668

MINI Cooper S E Countryman ALL4 (2018), $4,001

FCA North American Holdings, Fiat 500e (2013-2017), $7,500

Chrysler Pacifica PHEV (2017), $7,500

Ford Focus Electric (2012-2017), $7,500

Ford C-MAX Energi (2013-2017), $4,007

Ford Fusion Energi (2013-2018), $4,007

General Motors Cadillac ELR (2014, 2016), $7,500

General Motors Cadillac CT6 PHEV (2017), $7,500

General Motors Chevrolet Volt (2011-2018), $7,500

General Motors Chevrolet Spark EV (2014-2016), $7,500

General Motors Chevrolet Bolt (2017), $7,500

Kia Soul Electric (2015-2017), $7,500

Kia Optima PHEV (2017), $4,919

Mercedes-Benz smart Coupe/Cabrio EV (2013-2016), $7,500

Mercedes-Benz B-Class EV (2014-2017), $7,500

Mercedes S550e PHEV (2015-2017), $4,043

Mercedes-Benz GLE550e 4m PHEV (2016-2017), $4,085

Mercedes-Benz C350e PHEV (2016-2017), $3,000

Mitsubishi i-MiEV [Electric Vehicle] (2012, 2014, 2016, 2017), $7,500

Nissan Leaf (2011-2017), $7,500

Porsche 918 Spyder (2015), $3,667

Porsche Panamera S E Hybrid (2014-2015), $4,752

Panamera 4 E-Hybrid (2018), $6,670

Porsche Cayenne S E-Hybrid (2015-2018), $5,336

Tesla Roadster (2008-2011), $7,500

Tesla Model S (2012-2017), $7,500

TeslaModel X (2016-2017), $7,500

Tesla Model 3 Long Range (2017), $7,500

Toyota Prius Prime Plug-in Hybrid (2017), $4,502

Toyota Prius Plug-in Electic Drive Vehicle (2012-2015), $2,500

Toyota RAV4 EV (2012-2014), $7,500

Volkswagen e-Golf (2015-2017), $7,500

Volvo XC90 or XC90 Excellence (2018), $5,002

Volvo XC60 (2018), $5,002

Volvo S90 (2018), $5,002

Volvo XC-90 T8 Twin Engine Plug in Hybrid (2016-017), $4,585


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The Downside on the IRS Using Private Collection Agencies (PCA)

The IRS was to begin using PCA’s on a limited basis starting in April of this year. Our firm has yet to run across anyone who has had direct contact with one of the PCA’s. The National Taxpayer Advocate, Nina Olson, expressed her concern to congress in July about the IRS straying too far from the intent of the original legislation: IRC §6306 that was enacted in 2004 and amended in 2015 to restrict the IRS to outsourcing only inactive tax debts, and only those collections authorized by congress.

Under §6306, PCA’s are allowed to do three things; locate and contact a delinquent taxpayer, try to collect the full balance or enter the taxpayer into an installment agreement not to exceed five years, or obtain financial information from the taxpayer. Nina Olson believes that the IRS’s current Private Debt Collection (PDC) initiative is exceeding the authority of §6306 by allowing PCA’s to stretch the installments period to seven years, and allowing the PCA’s to monitor the six or seven year agreements and to receive commissions from the payments. “This is not authorized by IRC §6306,” Nina Olson, Private Debt Collection Program, July 5, 2017.

Of particular interest are the commissions arrangements included in the IRS’ PDC initiative. Under the current program the IRS can keep up to 25% of these collections without depositing the amounts into public coffers. The PCA’s can also be authorized to keep up to 25% for themselves. This effectively keeps up to 50% of the collections from this program out of the public coffers. One must also consider that when a tax debt ages, the total debt including penalties and interest will be at least twice the original unpaid tax amount.

Another major departure from protocol is that the IRS is not requiring the PCA’s to gather financial information before attempting to collect, which is standard procedure used by the IRS Collections unit. By not first gathering financial information, the PCA might end up pressing taxpayers into making installment payments, when the taxpayer may be experiencing an economic hardship; having trouble meeting basic living expenses. Some PCA scripts guide their collectors to encourage liquidation of assets or retirement accounts, or suggesting ways to borrow from other sources to repay the tax debts. Those encouragements, when made by an IRS specialist who has already evaluated the taxpayer’s financial status, are within the rules, but without PCA’s being held to the same standards, there is bound to be some abuse of taxpayer rights.

The answer on the demand side would appear to be to train and monitor the PCA employees. Whether that will happen is unclear at this time. If you, or someone you know is approached by a Private Collection Agency working for the IRS, it would be wise to contact a firm such as ours that specializes in representation so that the rights of the taxpayers can be upheld, because the PCA is not out to help anybody but themselves.

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Important Benefits for Employers in Qualified Hurricane Zones

Under Internal Revenue Code Section 139, employers can provide tax-free disaster assistance to employees. “Gross income shall not include any amount received by an individual as qualified disaster relief payment.” That means the employee will not pay withholding or employment taxes on the amounts received. The employer is allowed to expense the qualified disaster relief payments. Qualified payments would be for reasonable and necessary personal, family, living or funeral expenses incurred as a result of the qualified disaster.

Recent legislation included in the Disaster Tax Relief and Airport and Airway Extension Act of 2017 https://www.congress.gov/bill/115th-congress/house-bill/3823 also provides for a 40% “Employee retention,” tax credit on the first $6,000 of disaster wages, for a credit of up to $2,400 per employee. The regulations and specific guidance has not yet been made public.

If you are an employer within the disaster area, and your employees reside within the disaster area, and your business lost power for a week, yet you continued to pay the salaries of your employees, the legislation affords you the opportunity to take a tax credit for 40% of each employee’s salary for the period the business was impacted by the disaster up till the date operations were resumed, or until January 1, 2018, whichever comes first.

There are always exceptions, special circumstances, and restrictions where the affected employee has already taken advantage of another employment-related benefit. Contact your licensed tax professional or Payroll Company for more details as this legislation works its way to regulation and IRS guidance.

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Hurricane Relief for Casualty Losses

On September 29th President Trump enacted the Disaster Tax Relief and Airport and Airway Extension Act of 2017 https://www.congress.gov/bill/115th-congress/house-bill/3823. Among many other benefits, the act provides for relaxed rules pertaining to Casualty Losses. The IRS has not yet issued specific guidance on all of these matters. This blog focuses on claiming Casualty Losses under the relief rules.

In short, be sure to save any receipts for repairs that are a direct result of the storms because more generous Casualty Loss regulations will come into effect.

Normally, to claim a casualty loss the amount of out-of-pocket expenses that exceed insurance reimbursements must be greater than 10% of your adjusted gross income, plus an additional $100. Under the Act the 10% of AGI requirement is eliminated. The $100 floor is raised to $500.

The old rule is: 10% of AGI + $100 = floor for claiming a casualty loss as an itemized deduction on Schedule A. Assume you spent $10,000 on hurricane repairs and the insurance company gave you $7,000. That leaves $3,000 – $100 floor = casualty loss of $2,900. The $2,900 must now be greater than 10% of your AGI to make a claim on Schedule A.

The act makes it legal to make the claim as long as your casualty loss is greater than the new floor of $500. In our example, the taxpayer can claim $2,500 ($3,000 – $500 floor = $2,500 claim) regardless of their AGI.

The act also eliminated the need for the taxpayer to itemize deductions on Schedule A in order to get the special relief. The casualty loss is supposed to raise the standard deduction by the amount of calculated loss. Exactly how the IRS will regulate that has not yet been made clear.

What is clear is that, like money in the bank, you need to keep all records of hurricane-related expenses because the IRS guidance will be forthcoming. Provide your casualty loss numbers to your licensed tax professional with your other 2017 tax information.

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What is and Enrolled Agent (EA)?

Many CPA and tax offices employ Enrolled Agents but few outside of the tax industry understand what an EA is.

An Enrolled Agent is the only federally licensed tax professionals who are able to practice before the IRS in all matters. Attorneys and CPA’s are licensed by their states. EA’s can also represent clients before the US Tax Court after passing a procedural examination. The EA program is promulgated by the IRS. Although many EA’s work at the IRS, most do not. According to the National Association of Enrolled Agents there are approximately 48,000 practicing EA’s in the United States.

The position of Enrolled Agent was created after the Civil War as a response to rampant fraud involving war claims; mostly for horses lost in the war. It seems that claims for lost horses were substantially more than the entire US population of horses, alive or dead. Once citizens found out they could file a claim for a lost horse they sought out someone who could help them. Offices of make-shift claims preparers became common; not unlike crooked tax preparers today who pad tax returns with false claims.

The catchier phrase for the legislation is the “Horse Act of 1884;” signed into law by President Chester Arthur. After the proper training an agent could now be enrolled to be trusted to at least complete tax claims accurately.

The Revenue Act of 1913 greatly expanded the scope of the Enrolled Agent from that of clerk to include the authority to make claims for monetary relief for citizens who were having tax problems. As the tax codes grew and became more complex the expertise and responsibilities of the Enrolled Agent grew to keep pace. In many tax-related situations today’s EA’s exhibit skills on par with CPA’s and Attorneys.

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Upswing in Tax-related Scams

We read it in the industry blogs, get warnings in IRS notifications but it’s still surprising at how pervasive tax scams have become. When you get one, recognize it for the scam it is, and delete it immediately. Go about your business and unless they somehow get some of your money, informing the authorities will likely do little good.

In the last two weeks telephone scams have hit my wife twice, me once and last Friday one of our business office numbers was contacted and threatened. They use words like Income Tax Evasion, Warrant, Indictment, Summons, and that you had better call now, (or tap the attachment for your court date – in the case of an email) or “The cops,” will be coming for you.

All of these latest messages used automated voice technology, probably to hide their accents and sound official, but their diction still gives them away; “We will send the cops,” sounds like something they learned from TV.

The IRS will use a mailed Notice or Letter to make first contact with you if they have questions. Tax Evasion is a very serious and criminal offence which is difficult to prove in most cases. Because it is difficult to prove, smaller operators who fail to report income and get caught usually get the Civil Fraud penalty; 75% of the tax due on the income not reported. Civil Fraud requires much less work on the part of the IRS and achieves most of the same objectives; collects unpaid tax, punishes, and encourages future compliance. If you are a high-roller and the IRS has reason to believe there is a pattern of income tax evasion you might receive a visit from the criminal investigation division prior to any phone calls.

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Hurricane Hardship Withdrawal from 401K Warning

If any of our Florida clients are planning to, or have withdrawn money from your employer-sponsored retirement account under the hardship provisions as a result of Hurricane Irma, please consider what it means to withdraw money that is taxable. Although the early withdrawal penalty will not apply in the case of a hardship withdrawal, the amount will add to your taxable income; thus increasing your 2017 tax amount.

If you are using the Obamacare Advanced Premium Payments, making a hardship withdrawal from your 401k or other employer-sponsored retirement account will increase your family income for the year, and may result in you having to return some of your Obamacare money; called an Excess Advance Premium Repayment. Many of our clients already know what an unwelcome surprise this is. If you do not plan accordingly, you may owe both a higher tax, and have to return some of your Obamacare Premiums too.

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