Taxes and Your Subchapter S Corporation

Whenever I get a “run” of client calls about a specific topic, I assume that the Tax Universe is telling me to blog about it. Lately, that topic has been the tax rules for business owners who have elected to operate as a Subchapter S Corporation (Sub S). Business owners often form an LLC to protect their personal assets. An LLC can be operated for tax purposes in one of several ways, including the election to operate for tax purposes as a Sub S. That election has some advantages, but it adds more complexity as well.

If your business operates for tax purposes as a Sub S, or you are thinking about forming one, here are a few things to know:

  • Qualification – To qualify for Sub S status, the business must be a corporation that has between one and 100 shareholders who are domestic individuals, certain trusts, or estates. A Sub S can only have one class of stock. The corporation must have legal formation documents, an operating agreement, a separate tax ID, and documented shareholder meetings. 
  • Avoid Double Taxation – Sub S Corporations pass corporate income, losses, deductions, and credits through to their shareholders for tax purposes. However, there are a few exceptions when a Sub S is responsible for tax, such as built-in gains and passive income. Shareholders of a Sub S report their pro rata share of income and losses on their personal tax returns, subject to tax at the shareholder’s individual income tax rates. 
  • Shareholder Compensation – Sub S Corporations must pay reasonable compensation in the form of wages to a shareholder-employee if that the employee provides services to the corporation. Wages are reported on a W-2 and are subject to employment taxes. Net profits or losses from operations are reported on a Form K-1 and treated as non-wage distributions, which are not subject to employment taxes. 
  • Limited Losses – The fact that a shareholder receives a K-1 reflecting a loss does not mean that the shareholder is automatically entitled to deduct the loss. She or he must first have adequate stock and/or debt basis to claim that deduction. Each shareholder is responsible for tracking her/his own basis. Loss deduction amounts also depend on at-risk and passive activity loss limitations. 

These are just a few of the things to know when operating your business as a Sub S for tax purposes. There are a lot of rules on this topic, so visit https://www.irs.gov/businesses/small-businesses-self-employed/s-corporations and the “Related Topics” links on the right to get more details, instructions, forms, and all the other stuff you’ll need. Like I said, electing to operate as a Subchapter S Corporation has some complexities, so make sure you do your homework before getting started. Or think about consulting a qualified tax professional.

Need a Tax Payment Plan?

Many people are suffering financial hardship because of the COVID-19 economic downturn. 

Some of those people owed more money to the IRS when they filed their 2019 income tax return, but they didn’t have the funds to pay. Interest and penalties on unpaid tax balances keep adding to your tax debt, whether you have money or not. 

So, what do you do if you owe the IRS? Here is what you need to know:

  • Extended Payment Options – The IRS offers two ways for taxpayers to extend their tax payments over time:
  1. Short-term Payment Plan – If you can pay within 120 days, this option charges no fees and makes it easy to apply online. You’ll get an immediate notification of whether your application is approved. Interest and penalties continue to accrue until the tax is paid in full.
  2. Installment Agreement – Used when you need more than 120 days to pay, this option requires a set-up fee (e.g., $31-149 online and $107-225 via phone). Installment Agreements may require more information from you, depending on the balance due. Payments can be debited from your bank account, paid online, or by check. Credit card payments cost additional fees.

More details and a link to apply are at https://www.irs.gov/payments/payment-plans-installment-agreements#costs.

  • Tax Debt Amount Matters – Payment plan applications are generally easier to get approved for lower tax liabilities due than for large balances. Applications for $10,000 or less are automatically approved as a guaranteed Installment Agreement. For applications of amounts from $10-25,000, the approval is not guaranteed, and full payment must be made within six years. Tax debt payment plan applications for $25,000 up to $50,000 require information about your income, assets, and monthly expenses. Over $50,000 means a more thorough asset review to determine if anything can be liquidated to pay the tax due.
  • Offer in Compromise – A growing number of taxpayer households are suffering from long-term job loss, eviction, and medical issues with no insurance coverage. The IRS wants to collect all tax due but does not want to create an undue burden on taxpayers’ ability to provide for their basic needs. An Offer in Compromise allows you to settle your tax debt for less than the full amount owed if paying your full tax liability would create a financial hardship based on your assets, income, and expenses. See if you qualify at https://www.irs.gov/payments/offer-in-compromise.

Taxpayers who cannot pay their taxes due to the IRS in full have options to catch up. Depending on the amount due and your ability to pay, the IRS has extended payment plans and other mechanisms to avoid placing additional undue burdens on taxpayers who have already suffered financial hardship.

New IRS Standard Mileage Rates for 2020

Do you use your personal vehicle for business, charitable, medical or moving purposes? If yes, you could qualify you for an income tax deduction. How much you can deduct and how you report the expense depends on your particular situation. The rules say that qualified deductible vehicle expenses can total the greater of actual expenses or a standard rate. Both expense options are based on the number of miles driven for business, charitable, medical or moving.

Most people choose to use the standard rate because it’s easier and usually results in a larger deduction amount. The standard mileage rate is determined each year by the Internal Revenue Service based on data about the cost of operating and maintaining a vehicle, including passenger cars, vans, pickups and panel trucks.

The IRS recently issued the new standard mileage rates for 2020 to calculate the deductible costs of operating a vehicle for business, charitable, medical or moving purposes. Beginning on January 1, 2020, the standard mileage rates were reduced or stayed the same. Here are the details:
 

  • 57.5 cents per mile driven for business use, down 0.5 cents from the rate for 2019,
  • 17 cents per mile driven for medical or moving purposes, down 3 cents from 2019, and
  • 14 cents per mile driven in service of charitable organizations. The charitable rate is set by statute and remains unchanged.

Even at the lower rates, that standard mileage rate can really add up. Remember that you always have the option of calculating the actual costs of using your vehicle instead of using the standard mileage rates. Also remember that you have to track your mileage by category (e.g., business and personal) for each vehicle no matter which method you use.

Taking vehicle deductions for business, charitable, medical or moving purposes involves a lot of tracking, but the effort can be worth it. There are apps you can put on your phone to help. Once you get your system down, you’ll see that those deductions can add up and reduce the bottom line on your tax bill.

Got an IRS Notice – Now What?

Open Manilla folder with a calculator, check book and pen on one side, and a stack of paper that says "Tax Withholding and Estimated Tax" on the other. A cup of coffee is placed above the folder on a dark background.
Photo by Kelly Sikkema on Unsplash

You’re flipping through the mail when you see it. An envelope with an IRS return address. OMG! What’s this about? Whether you set it aside for a while or rip it open immediately, you eventually see it – a Notice from the IRS with news that you may not want to hear.

Now what? Your IRS Notice will explain the reason they are contacting you and give you instructions on how to handle the issue. Sure, you might have made a mistake on your return, but you might just need to clarify some information. Let’s break this down into a little Q&A to simplify things. You’re already nervous about this, right?

Why was I notified by the IRS?

The IRS sends Notices to taxpayers who have a balance due, are due a larger or smaller refund than originally reported, their return has been changed or additional information is needed. Notices may also communicate the need to verify taxpayer identity or a delay in processing the return. Each Notice contains a lot of valuable information about the issue. Read it carefully.

How should I respond?

Typically, you only need to respond if you don’t agree with the information in the Notice, if the IRS requested additional information, or if you have a balance due. If the income or payment information the IRS has on file doesn’t match the information you reported on your tax return, check your return to see if you made a mistake. It happens. Just pay the amount due, or at least as much as you can.

What if I don’t agree?

Yes, sometimes the IRS makes a mistake or does not understand the information from your filed tax return. If that’s the case, make copies of any schedules or other documentation that clarifies your situation. Complete the Notice Response Form and include any explanation to help the IRS understand what you are sending. Don’t assume that the IRS will be able to interpret your documents without a brief explanation.

When should I respond?

IRS Notices generally require you to respond by a specific date. There are two main reasons you’ll want to meet that deadline – to minimize the accrual of additional interest and penalty charges, and to preserve your appeal rights if you don’t agree. Keep copies of all Notices and your response (with support documents) in your tax records, in case you need to refer to them later.

Getting an IRS Notice is nerve-wracking, but ignoring it will only make it worse. Read the Notice carefully and respond with an explanation by the due date if you don’t agree. Made a mistake? Pay the amount due, or as much as you can, to reduce additional interest and penalties. When you know what to do, getting an envelope with an IRS return address won’t make your heart skip a beat.

Bankruptcy and Your Taxes

You may have wondered what tax professionals do after the filing deadline. What? You’ve never wondered about that? Well, I’ll tell you anyway. Tax professionals use “down time” to keep up with tax law changes with continuing education. Last week, I got one of my 2019 continuing education hours by taking a free IRS webinar, all about what an individual or business taxpayer should know about taxes when filing for bankruptcy.

Hopefully, none of you (or any of my clients) will be in this situation. But, just in case, I’m sharing a few tips I learned from the IRS webinar, “Understanding Bankruptcy from an IRS Perspective”:

Notify the IRS

Anyone who has filed for bankruptcy, or who is in the process of filing for bankruptcy, should contact the IRS’ Centralized Insolvency Operations (CIO) Unit to report the filing. The bankruptcy could be related to unpaid taxes or not. The CIO will place a “hold” on any federal tax collection activities for the duration of the bankruptcy case. They also coordinate the IRS’ representation if there are any unpaid federal taxes.

Check Your Status

For individuals, the most common type of bankruptcy is a Chapter 13, although they sometimes file under Chapter 7 or Chapter 11. Chapter 13 bankruptcy is only available to wage earners, the self-employed and sole proprietors. To qualify, a taxpayer must have regular income, have filed all required tax returns for the four years prior to the bankruptcy filing and meet other requirements in the bankruptcy code.

Meet All Deadlines

During the bankruptcy case, the taxpayer must continue to file, or get an extension of time to file, all required income tax returns. All current taxes must be paid as they come due. Failure to file returns and/or to pay current taxes for the duration of the bankruptcy case may result in the case being dismissed with no discharge of tax debt.

What Else to Expect

Tax refunds can be received while in bankruptcy. However, refunds may be delayed or used to pay down tax debts. Successfully completed bankruptcy plans result in a discharge of debt, releasing the debtor from personal liability for the discharged debts. Some taxes may be discharged, depending on the facts and circumstances of the case.

You now have an idea of what to do about taxes when filing for bankruptcy. Plus, you’ve learned what tax professionals do after the filing deadline – keep up with tax law changes with continuing education.

TIME FOR YOUR MID-YEAR TAX CHECK-UP

Does it seem like you just took down the Christmas tree? Well, believe it or not, 2018 is half over! That means the tax year is half over, too. Only six months to avoid getting an expensive surprise when filing your taxes next year.

 

Doing a mid-year tax withholding checkup is even more important this year than it was before. Changes in the Tax Cuts and Jobs Act passed in December 2017 could impact your 2018 tax bill dramatically, depending on your family size and make-up, income level and location.

 

So what are the tax law changes that taxpayers should be aware of? Three areas are likely to make your 2018 tax bill look a lot different from 2017:

 

  1. Itemized Deductions – Deductions for state and local income, sales, and property taxes are limited to a total of $10,000. Home mortgage interest is limited on new mortgages to balances of $750,000. Deductions are eliminated for home equity interest unless used to purchase or improve a home. Non-disaster personal casualty losses, tax preparation and investment fees are eliminated. One bit of good news for high income taxpayers — the itemized deduction phase-out is eliminated.

 

  1. Personal Exemptions and Standard Deduction – The $4,050 per person personal exemption is eliminated. That will hit some families pretty hard. Losing personal exemptions hasn’t come up much in the news, but taxpayers will definitely notice when filing in 2019. Doubling the standard deduction has been a huge news headline. For example, married couples filing jointly will get a $24,000 standard deduction for 2018, instead of $12,700 for 2017. Millions of taxpayers will find that the standard deduction is more beneficial than itemizing.

 

  1. Tax Bracket – Six of seven individual tax brackets are reduced. Most taxpayers will benefit from the new rates, which range from 10% to 37%. Even after calculating the impact of losing some itemized deductions and all personal exemptions, lowering the rate results in a lower overall tax for many taxpayers. However, some taxpayers who were in the 33% marginal tax bracket will find themselves in the 35% marginal bracket in 2018. This unfavorable change will mainly affect singles and heads of households with taxable income between $200,000 and $400,000.

 

All of these changes means that it’s even more important to check on your tax withholding and plan ahead for next tax season. Tax projection calculators are available to help determine what your new income tax bill will look like. Of course, www.irs.gov is a great resource. The Tax Policy Center also posted a tool that appears easy to use – http://tpc-election-calculator.urban.org/.

 

Whichever tax calculator tool that you choose, don’t wait to do your mid-year tax withholding checkup. It will be time to put up the Christmas tree again sooner than you think!

 

 

Fraud and Workplace Culture

Last week’s blog was about the three types of fraud and how to prevent them. Typically, organizations lose 5 percent of revenue to fraud each year. Think about how much that means to your organization’s bottom line. Not pretty. Fraud hits smaller organizations and nonprofits even harder, which means a bigger bite out of annual revenue.

 

The Association of Certified Fraud Examiner’s 2018 Report to the Nation on Occupational Fraud and Abuse says that the median loss of fraud cases examined over the last two years was $130,000. Twenty-two percent of losses exceeded $1 million!

 

Organizations can be reluctant to report fraud to law enforcement for two related reasons – bad publicity and poor internal disciplines. Reputations and bottom lines are hurt when a fraud case is exposed in the headlines. It’s even worse when the story behind the headline reveals that financial controls and oversight were so lax, the organization essentially handed the stolen funds to the fraudster.

 

Financial controls that fail to detect or prevent fraud are the symptom of a larger issue – poor workplace culture. What is that, and why is it important? Workplace culture is the personality of an organization – the values, accepted behaviors and attitudes that make the environment and its people work together.

 

Part of a strong workplace culture is promoting ethical, honest and transparent actions, starting with senior management. A strong tone at the top goes a long way to letting everyone in the organization know that dishonest and unethical behavior is not tolerated. Fraud is less likely to occur in an organization with strong workplace culture and tone at the top.

 

So here’s the ironic part. In a recent report, The Culture Economy, 60% of smaller business leaders think that strong organizational culture is a “nice to have” thing, not a necessity. What?! Just look at the fraud statistics to see how essential workplace culture is to the financial success of an organization. Sure, not everyone working in a place with lax financial controls is going to commit fraud; but lax controls make it easy for the dishonest or financially-stressed employee to steal or engage in corrupt practices.

 

A strong workplace culture lets your employees know that fraud and other dishonest behavior will not be tolerated. Of course, strong financial controls and oversight are important. Clear messaging about expectations and appropriate actions go a long way to making sure your employees know that fraud will not be tolerated.

Phishing for your Tax Dollars

I hadn’t quite decided on this week’s blog topic when I saw an e-mail snagged in my spam folder. The sender was “IRS”. The heading was “Second Notice of Delinquent Taxes”. What a gift! A blog topic!

 

Like many taxpayers who receive a message from the “IRS” dunning them for cash, I knew that I didn’t owe the IRS anything. Thankfully, I knew better than to open or reply to it. Keep reading to know how to identify phishing, and what to do when it happens to you.

1.      What is phishing?

 

Phishing is a scam usually done through unsolicited email and/or websites that pose as legitimate senders or sites. Scammers use phishing to lure unsuspecting victims to provide personal and financial information. Bogus emails can appear to come from the IRS or your tax professional requesting information, including mother’s maiden name, passport and account information that is used to steal your identity and assets.

 

  1. How do I know if it’s phishing or really the IRS?

 

The easiest way to check for phishing is to place your cursor over the sender’s name, revealing the sender’s e-mail address. An address that doesn’t look legitimate is probably a scam. For the IRS, anything other than “irs.gov” is suspect. The IRS doesn’t initiate contact with taxpayers by email, texts or social media to request money or financial information. Most IRS communication is still through the good, old-fashioned USPS.

 

  1. What should I do with a phishing e-mail claiming to be from the IRS?

 

If you receive an email claiming to be from the IRS that contains a request for delinquent tax balances or financial information, immediately do the following:

 

  1. Don’t reply.
  2. Don’t open any attachments. They can contain malicious code that may infect your computer or mobile phone.
  3. Don’t click on any links. Visit the IRS’ identity protection page if you clicked on links in a suspicious email or website and entered confidential information.
  4. Forward the email as-is to the IRS at [email protected].
  5. Delete the original email.

 

Don’t get phished! When you get an e-mail that looks suspicious or is from an unfamiliar sender, stop and check it out before deciding to open it. If it’s phishing for your tax dollars, don’t even think about opening it! Just forward to [email protected] and delete!