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Taxes and LLCs

Regular readers of my blog posts know I’ve addressed LLCs and taxes before. Questions about how to file taxes for an LLC still come up all the time, including last week at my Start-Up with Financial Success workshop at BizLaunch/Arlington Economic Development. So I decided to pull up a blog from “the Archives” and update it to share again.

Piece of paper that says "TAX" with hand holding pen

The first question I ask new tax clients who own a business is, “What type of business do you have?” The response I often get is “I have an LLC.” That answer isn’t enough information for me to know how and when to file their business taxes. I need to ask more questions at that point, like “and how do you operate for tax purposes?” Answering that one can be tough. 

An LLC is a state-defined limited liability legal business structure. Business owners often form an LLC to protect their personal assets in case their business is sued. An LLC can file business income taxes in one of three different ways, depending on the circumstances:

  1. Sole Proprietorship

Individual business owners that have not incorporated are, by default, a Sole Proprietor. Sole Proprietors report income and expenses on a separate form filed with the owner’s individual income tax return, IRS Schedule C, “Profit or Loss from Business.” A separate Schedule C must be filed for each business that the owner operates. Net business profits are subject to income tax and the employer and employee portions of Medicare and Social Security taxes (i.e., 15.3% in 2019).

  1. Partnership

Two or more individuals in business together without incorporating are, by default, a Partnership. Partnerships are considered a separate tax entity and are required to file a separate income tax return, IRS Form 1065, “U.S. Return of Partnership Income.” Partners receive an IRS Form K-1 for each one’s pro-rata share of non-wage income and expenses, based on the operating agreement (a MUST). Partners are responsible for tracking the basis of their shares to determine how distributions are taxed.

  1. Subchapter S Corporation

Qualifying businesses can take the Subchapter-S election and avoid the double taxation of a C Corp. A number of rules apply to see if a business owner(s) qualifies. Sub-S Corps are also considered a separate tax entity and are required to file a separate income tax return, IRS Form 1120S, “U.S. Income Tax Return for an S corporation.” Shareholders receive an IRS Form K-1 for their share of non-wage income and expenses, based on the operating agreement (again, a MUST). Owner/employees earn wages and get a W-2.

Determining how your LLC operates for tax purposes is not easy. It depends on the circumstances and many rules apply. Need more information? The IRS has you covered, as usual. Check out their tax information, tools and resources for business and self-employed individuals at https://www.irs.gov/businesses.

The Earned Income Tax Credit Still Exists!

Many of the tax rule changes under the 2017 Tax Cuts and Jobs Act eliminated or reduced tax benefits that we were used to. For example, miscellaneous itemized deductions and personal exemptions are gone and deductible state and local taxes are capped at $10,000. Isn’t there any good news about taxes? Yes! The Earned Income Tax Credit, or EITC, still exists! 

Don’t leave money on the table!

EITC is a valuable tax benefit for working people with low-to-moderate income. Eligibility and the credit amount depend on your earned income and number of eligible children in your household. For example, in 2019, a married couple that earns up to $52,493 with two eligible children could get a $5,828 federal tax credit. For 2018, the average EITC credit was $2,445. 

Five things that you should know about EITC:

  1. A tax credit is even better than a tax deduction because it’s a dollar-for-dollar tax liability reduction, not just a reduction of taxable income.
  2. EITC is a refundable credit and could reduce your tax liability to a “negative” amount. Your refund could be even bigger than the amount of federal taxes that were withheld from your paycheck. 
  3. Taxpayers qualify based on their income, the number of children they have, and the filing status they use on their tax return. For a child to qualify, they must live with the taxpayer for more than six months of the year.
  4. To qualify for EITC, you must have earned income (e.g., wages or self-employment income) that cannot exceed an IRS-specified amount that is adjusted annually. Taxpayers may move in and out of EITC eligibility, especially after major life events.
  5. To get the credit, you must file an income tax return, even if you do not owe any tax or are not otherwise required to file. 

Some people don’t know about EITC or they do not know that they qualify. Each year, 30% of the EITC-eligible population is new to this valuable tax credit, many of whom don’t know about it. Not taking a credit that you qualify is just like giving away money! Who wants to do that? Don’t miss out on your EITC refund. Don’t let your friends and family miss out on their EITC refunds. 

Need help? Get details about income limits, credit amounts and eligibility at https://www.irs.gov/newsroom/the-earned-income-tax-credit-can-put-money-in-taxpayers-pockets.

Is Your Computer Secure?

We use our computers and other devices every day. Cyber thieves know that, so they work every day to break into computer systems to steal valuable financial and personal data. We are all vulnerable and we all need to protect ourselves. Security advice to protect your data is everywhere. But how can you sift through all of it? 

That red screen can’t be good!

Here are five tips compiled from different reliable sources to help you create a secure computer environment and protect your private information:

  • Anti-virus Software

Anti-virus software scans computer files or memory for certain patterns that may indicate the presence of malicious software and looks for patterns based on the signatures or definitions of known malware from cyber criminals. Anti-virus vendors find new issues and update malware daily, so it is important that you have the latest updates installed on your computer. Keep security software set to automatically receive the latest updates so that it is always current.

  • Firewalls

Firewalls provide protection against outside attackers by shielding your computer or network and preventing malicious software from accessing your systems. Firewalls can be configured to block data from certain suspicious locations or applications while allowing relevant and necessary data through. But remember, firewalls do not prevent attacks; they protect against malicious traffic (unless the user accidentally installs malware – see “phishing” below).

  • Two-Factor Authentication

Many email providers now offer two-factor authentication protections to add an extra layer of protection. Often, two-factor authentication means the returning user must enter username and password plus another step, such as entering a security code sent via text to a mobile phone. A thief may be able to steal the username and password but it’s highly unlikely they also would have the mobile phone to receive the code and complete the process.

  • Backup software/services

Critical files on computers should routinely be backed-up to external sources, such as a copy of the file is made and stored either online as part of a cloud storage service or saved to an external hard drive. Periodically verify that the files are backed up and can be retrieved.

  • Phishing emails

Never open an email from a suspicious source, click on a link in a suspicious email or open an attachment without scanning it first. Otherwise, you could be a victim of a phishing attack and your data could be compromised. Never click links within pop-up windows, download “free” software from a pop-up, or follow email links that offer anti-spyware software. The links and pop-ups could be installing the spyware that they claim to be eliminating. 

You may assume that the information you have on your computer is not valuable to a cyber thief. But think about it; access to your personal information, bank accounts and credit cards are all that cyber criminals need to steal your identity and create havoc in your personal life. Following these five cyber security tips will help you create a secure computer environment and protect your financial and other personal information.

Income Taxes for Military Spouse Entrepreneurs

I grew up as a military dependent. So I was particularly thrilled when the National Military Spouse Network asked me to participate in a panel discussion for military spouses who are also entrepreneurs. The panel discussion, Three Key Business Advisors Every Milspouse Business Owner Should Have in Their Network, included an attorney who specializes in business formation, a business consultant who specializes in start-up planning and resources, and a tax professional experienced in solving tax-related issues for business owners (that was me, by the way).

The military spouse entrepreneurs asked a lot of detailed questions. Many of them raised issues that are peculiar to running a business with frequent household moves and tax rules that are not universally understood by taxpayers and tax professionals alike. Three topics that we discussed are highlighted here:

  1. State Income Taxes for Net Business Profit

Generally, active duty military personnel and their spouses only have to file a state income tax return where they are legally domiciled as their permanent legal home. However, states where business revenue is generated expect to get some income tax revenue from that business. That requires the filing of a non-resident state income tax return to report the portion of the net business profit that was “sourced” in that state. The good news – income reported to and taxed by the “source” state is deducted from the taxable income of the state where the military spouse is a legal resident.

  1. Finding Tax Help that Knows the Rules for Military

Finding a tax preparer who understands tax rules for active duty military and their spouses is a challenge, especially with all the different state rules that are involved. The need for qualified and knowledgeable tax help is evident from reading #1, above. The IRS has some tips for finding the type of tax professional that you need, credentials to look for and a directory of tax preparers by state who have completed annual tax training at https://www.irs.gov/tax-professionals/choosing-a-tax-professional. Taxpayers should also interview several tax preparers to make sure they feel comfortable with the relationship. 

  1. Finding Reliable Resources

Clear and reliable information sources are essential, but challenging to locate. A few of the websites I shared with the military spouse entrepreneurs were Military Benefits Info (https://militarybenefits.info/military-spouse-act-residency-relief-msrra/), Tax Information for Active Duty Military and Reserve Personnel (https://www.irs.gov/pub/irs-pdf/p4940.pdf) and Armed Forces Tax Guide (https://www.irs.gov/pub/irs-pdf/p3.pdf). Individual military installations may also have tax advice resources available.

This National Military Spouse Network panel discussion for entrepreneurs highlighted the challenges encountered by business owners who move frequently and are subject to complicated tax rules. I hope that the information shared by the Three Key Business Advisors Every Milspouse Business Owner Should Have in Their Network was helpful to everyone who attended and to my readers who serve our country.

When Rental Real Estate Qualifies as a Business

Cartoon picture of someone holding a white sign with dollars and coins.

The Tax Cuts and Jobs Act (TCJA) was signed and enacted in December 2017. In September 2019, almost two years later, the IRS issued final guidelines about whether taxpayers who rent real estate qualify for a new deduction under TCJA, the Qualified Business Income Deduction, aka “Code Section 199A”.  Section 199A allows business owners to deduct 20% of net business income on her or his individual income tax return. 

This new deduction is a very attractive tax benefit for eligible taxpayers. Who is eligible? TCJA extended the benefit to the owners of rental real estate but did not make clear what properties qualify and how to substantiate rental activities. Taxpayers and tax professionals had to use their best judgement to file 2018 income tax returns. Good news – guidance released last month clarifies when rental real estate is treated as a trade or business and how to substantiate the 199A deduction.

The September 2019 IRS guidelines state that rental real estate will be treated as a trade or business if the following requirements are satisfied during the tax year:

  • Maintain separate books and records of income and expenses for each rental property. You’ve already been doing that all along, right?
  • Perform 250 or more hours of rental services on rental activities. Good news – taxpayers with more than one rental property combine all activities to meet the 250 hours (i.e., the hours requirement is NOT per property).  Activities include advertising to rent the real estate; negotiating and executing leases; and management, operation, maintenance, and repair of the property, even services performed by a contractor or employee.
  • Maintain contemporaneous records, including time reports, logs, or similar documentation of the description and hours of all services performed; dates when such services were performed; and who performed the services (i.e., a contractor). Records could be requested by the IRS to substantiate rental activities.

As usual, the IRS guidelines address exclusions from Section 199A eligibility, including:

  1. Travel to and from the rental property does not count towards the 250 hours of rental services. 
  2. Real estate used by the taxpayer as a residence for any part of the year is not eligible.
  3. Real estate rented under a triple net lease is also not eligible, although the activity may qualify as a trade or business, depending on the owner’s business activities. 

There’s more! Starting with 2019 individual income tax returns, taxpayers with activities that qualify for the Section 199A deduction must include a statement indicating that the 199A deduction is being claimed using a new form, Form 8995, Qualified Business Income Deduction

Want more details? The IRS website has them here https://www.irs.gov/newsroom/irs-finalizes-safe-harbor-to-allow-rental-real-estate-to-qualify-as-a-business-for-qualified-business-income-deduction

Will Your Wishes be Granted?

You’ve spent years planning for your financial future, accumulating assets. If the unexpected were to happen, would your assets be given to the people that you want to get them? Will your wishes be granted? 

Estate planning is a complicated topic that should be addressed by an attorney. However, one simple and important estate planning action you can take immediately is to designate a beneficiary for your financial assets. If you’ve already named beneficiaries to inherit your assets, check them periodically to make sure that they reflect current reality.

Financial assets to name and check on beneficiary designations include: 

  • Bank accounts
  • Brokerage accounts
  • Retirement accounts
  • Company benefit plans
  • Life insurance policies
  • Annuities
  • 529 College savings accounts

Sure, we all think that we have plenty of time to designate beneficiaries and make sure our wishes are followed. But putting it off can lead to unforeseen and undesirable consequences. If you need motivation, here’s a real-life horror story to light a fire under you.

“Dad” failed to change the beneficiary designations for his pension benefits and life insurance after his divorce, so Dad’s former wife was still the named beneficiary. Two months later, Dad died in a car crash. The Court ruled that the beneficiary designations overruled a state law that would have automatically disinherited the ex-wife. So, the ex-wife received the money, and the kids were handed the bills for an unsuccessful legal fight.

Divorce is not the only situation where failing to turn in or update beneficiary designation forms can cause heartache for your intended heirs—it’s just the most obvious situation. You get the idea. When things in your life change, you may need to refresh your beneficiary designations.

Other tips:

  1. Probate – Another big reason to designate beneficiaries: it avoids probate. Also, consider naming contingent beneficiaries. These are individuals who stand in line behind your primary beneficiaries. 
  2. Living Trusts and WillsAs a general rule, whoever is named on the most recent beneficiary form will get the money automatically when you die—regardless of what other documents might say.      
  3. Check – Review your designations at least once a year or whenever significant life events occur. It usually takes only a few minutes to conduct a checkup and make any needed changes. Often you can access the necessary forms online. 

Don’t wait if you want your wishes to be granted.

Extended Tax Returns Due October 15

Way back in April when you got an extension to file your 2018 income tax returns, you breathed a sigh of relief. Phew! Six additional months to file. Seemed like all the time in the world. Well, “all the time in the world” had passed and you are up against another deadline to file – by next Tuesday. No more extensions and no more excuses.

Two tips about filing extended income tax returns:

File by October 15th

It’s really down to the wire now. No additional filing extensions are available after October 15th. The mad scramble is on to get replacement copies of missing wage statements, organize your business expenses and scan your bank account statement for charitable contributions. If you really cannot get your business expense information organized as thoroughly as you should, use your best estimates and file a return by the due date. Then, finish getting those documents together and file an amended return. Failure-to-file penalties are expensive.

If You Still Owe

Even if you paid with your extension request, you could still end up owing more. If that’s the case, pay as much as possible with your return to reduce interest and penalties. Keep in mind that interest accrues daily on unpaid tax balances. It’s free to use IRS Direct Pay to securely pay from your checking or savings accounts. Can’t pay it all now? The IRS offers payment plan options, allowing you to pay over time. Details about all of these options (and their costs) are all found at the Paying Your Taxes page on IRS.gov.

Filing an extension in April feels terrific, until that six-month reprieve flies by and you there you are. Confronted with another deadline. Less than a week to go. No more excuses. Go ahead and get started. Maybe it won’t be as painful as you imagine. Need help meeting the October 15th tax filing deadline? Go to the IRS website at https://www.irs.gov/newsroom/the-filing-deadline-for-extension-filers-is-almost-here. Need more guidance? Consult a qualified tax professional.

Start-up with Financial Success Workshop

If you’ve started a business within the last year, you know how easy it is to get overwhelmed by the financial aspects. From choosing the right accounting software, to setting up your service agreements, to paying your quarterly tax estimates, there are so many big decisions that you make up-front that can affect the long-term health of your business. 

Unless you have a formal business or finance background, handling all the details can be rather intimidating. On the other hand, even if you do have business finance skills, should you be spending that time away from building your business? No!

Start-up business owners need straight answers from experts with the experience and knowledge that will lead to financial success. My upcoming Start-Up with Financial Success workshop is just what you need! This one-day, in-person workshop is presented by me and four other professionals to cover the basics of financial management for small businesses to set up healthy financial habits from the start. 

Unlike other trainings that only focus on one financial discipline, this workshop is led by five experts in different aspects of financial management: Legal, Bookkeeping, Taxes, Accounting and Business Operations. These experts bring decades of combined expertise to cut through the confusion and overwhelm and pave the way to financial success.

Register here – https://www.eventbrite.com/e/start-up-with-financial-success-tickets-72274235183

The Start-Up with Financial Success workshop will answer common questions, such as:

  • What type of legal business entity should I establish?
  • What’s the difference between a bookkeeper and an accountant, and how can they help my business? 
  • How do I choose the right accounting software?
  • How do I make sure the language in my services agreement or other contracts give me the legal protections I need?
  • How do I keep all my financial information organized?
  • What are quarterly tax estimates and how do I pay them? 

Can you tell that it’s going to be a jam-packed day? Interested?  Register now at this link – https://bit.ly/2m6UWP7 Look forward to seeing you there!