Tax Options for Your LLC

New tax clients and workshop participants who own a business often ask about their taxes when they have formed an LLC. My answer is, “It depends.” I realize that is not a satisfying response, but unless I know more about the business and its ownership, I cannot provide an accurate reply. It’s often the case that correctly answering tax questions depends a lot on your circumstances. 

Here’s why. 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. How an LLC operates for tax purposes has some default provisions and other options that primarily depend on the number of business owners.

An LLC can file business income taxes in one of three different ways:

  • Sole Proprietorship

An individual business owner that has not incorporated is, 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.” Net business profits are subject to income tax and the employer and employee portions of Medicare and Social Security taxes (i.e., 15.3% of net business profit).

  • 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). 

  • 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 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.

Advanced Child Tax Credit Starts July 15th

The Advance Child Tax Credit, part of the $1.9 trillion American Rescue Plan, starts on July 15th .
Eligible families will receive monthly payments of up to $300 per qualifying child from July
through the end of 2021 to help them bridge the financial gap caused by the COVID-19
pandemic. Advance Child Tax Credit payments are based on tax credits that would ordinarily be
received next year when income tax returns are filed for 2021.

Taxpayers who filed a tax return for 2019 or 2020 should receive their first Advance Child Tax
Credit payment on or around July 15th . Taxpayers who provided bank information with their filed
federal income tax return should see the payment direct deposited into their bank account. If the
IRS does not have bank information on file, the taxpayer will receive the payment in a check mailed to the address it has on file.

What about people whose income for 2019 and 2020 wasn’t high enough to have to file an income tax return? The IRS established an online Non-filer Sign-up tool to help them register for the monthly Advance Child Tax Credit payments by providing required information about
themselves, their qualifying children aged 18 and under, and their bank information so the IRS
can deposit the payments into their checking or savings account.
Eligible families need to know these facts about the Advance Child Tax Credit:

  1. The Child Tax Credit increase and Advance Payments are in effect for 2021 only, unless
    extended by new law.
  2. The Child Tax Credit is increased from $2,000 to $3,000 per eligible child, for children
    who are age 6 and older, and to $3,600 per eligible child for children under the age of 6.
  3. The age for qualifying children is increased from children under age 17 to children under
    age 18, thereby increasing the number of eligible children.
  4. The Child Tax Credit is fully refundable, meaning that eligible taxpayers could receive a
    tax refund that exceeds her or his tax federal withholding.
  5. Income limitations for the Child Tax Credit remain at $200,000 for single taxpayers and
    $400,000 for married filing joint. The Additional Child Tax Credit is phased out by $50
    for every $1,000 of modified adjusted gross income above the threshold.
  6. Any eligible Child Tax Credit not paid in advance from July to December 2021 will be
    received after the taxpayer files her or his 2021 federal income tax return.
    The Advance Child Tax Credit gives eligible families up to $300 a month per qualifying
    child through the end of 2021 to help them bridge the financial gap caused by COVID-19.
    Want to know more? The IRS recently posted FAQs at https://www.irs.gov/credits-
    deductions/2021-child-tax-credit-and-advance-child-tax-credit-payments-topic-d-calculation-
    of-advance-child-tax-credit-payments.

Act Now and Reduce Tax Stress Later

Rejoice! The 2020 tax filing season is finally over! That is, unless you needed more time to file and requested an extension after reading my May 5th blog post (https://buff.ly/3t0X73l). Between all the changes from the COVID-19 relief packages and deadline delays, this tax filing season was another wild ride for taxpayers and their preparers. 

Well, how did it go for you? Stressful? Expensive surprises? Not knowing what to expect makes an already stressful situation – doing your taxes – even worse.  Here are a few actions to take now that will reduce your tax stress later:

  • Do a “Paycheck Checkup” 

Did you owe a lot when you filed for 2020, or did you get a big refund, aka an interest-free loan to the government? An IRS Paycheck Checkup can help to make sure you don’t get an expensive surprise when you file your 2021. Use this online tool to see if you need to change your withholdings https://www.irs.gov/paycheck-checkup. Have investment other non-wage income? Check on whether you need to make quarterly estimated tax payments here https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes

  • Make Tax Payments Electronically

Using any of the IRS electronic payment options puts you in control of paying your tax bill. You determine the payment date and receive an immediate confirmation from the IRS. It’s easy, secure, and much quicker than mailing in a check or money order. Go to IRS.gov/payments to see all the free electronic payment options: online, by phone or from a mobile device using the latest encryption technology. Check with your state for online payment options.

  • Contribution Deduction for Nonitemizers

Even if you don’t itemize and take the standard deduction, you may be eligible to take a charitable deduction for cash contributions up to $300 made to qualifying charities in 2021. Eligible contributions must be made via cash, check or credit card. Use the IRS Interactive Tax Assistant tool – Can I Deduct My Charitable Contributions? – for answers about cash donations.

  • Tax Credit Eligibility

You could qualify for credits like the Child Tax Credit and Child and Dependent Care Credit. You might be able to claim the Credit for Other Dependents if a dependent is not your child. If you pay qualifying higher education costs for yourself, your spouse, or a dependent, you may be eligible for education tax credits or deductions. Taxpayers earning $57,414 or less can check if they qualify with the EITC Assistant, available in both English and Spanish.

Now, immediately after filing your 2020 tax returns, is the perfect time to act and reduce tax stress next filing season. Whether you prepare your own taxes or use a tax preparer, the more you know in advance, the less stressful that your tax return filing experience will be for 2021.

Not Ready to File by May 17?

For the second year in a row, the income tax filing deadline is delayed. This year, the filing due date for the IRS and most states is May 17th instead of the “normal” April 15th. Despite the delay, the tax deadline can sneak up on you. If you’re in a panic because you haven’t started gathering your tax documents, you can probably relax. 

You can request a tax filing extension to postpone from May 17th to October 15th. You don’t need to provide a reason for needing the extension, but it does take a little time to get it done right and avoid possible underpayment penalties.

Three tips for getting an income tax filing extension:

  1. You Must Apply

Individuals can request a tax filing extension by filing IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, online at the IRS website, via approved tax software, or in paper form. It must be sent or postmarked no later than midnight on the original due date. The extension is automatically approved if a refund is expected or if the estimated amount due is paid with the extension request.

  1. Pay Amounts Due

Use the IRS Form 4868 instructions at https://www.irs.gov/pub/irs-pdf/f4868.pdf to estimate your 2020 income tax liability. Compare your estimated taxes to your tax withholding or quarterly estimated payments and enter the numbers on the extension request. If you owe more in taxes than you’ve paid in, the balance due must be paid with the extension request. Failure to pay the amount due results in an underpayment penalty and interest accrued daily on the unpaid balance.

  1. Check Your State

Each state has its own set of rules and processes for its residents to request an income tax filing extension. As mentioned above, most states followed the IRS and delayed their 2020 tax filing deadline, but some did not match the IRS’ May 17th deadline. Check your state’s tax department website for deadline updates and links to information about requesting an extension of time to file for 2020.

Rushing at the last minute is stressful and causes mistakes, especially with an already stressful activity like filing your income tax returns. Get more time to file your 2020 federal income tax return by requesting a tax filing extension. Go to the IRS website at https://www.irs.gov/forms-pubs/extension-of-time-to-file-your-tax-return for details and help estimating any taxes you owe with the extension request.

Business Meal Deduction Update

Legislation recently passed by Congress for COVID-19 relief contains some tax rule changes that are intended to encourage taxpayer spending. One change that took effect January 1, 2021, temporarily increases the business deduction for meals from 50% to 100% until the end of 2022.  The deduction increase could provide business owners the incentive to enjoy a not-from-home meal while conducting business activities.

As usual, the temporary rules are not simple. The IRS guidance recently announced the details and definitions needed by taxpayers to follow the rules while also doubling their business meal deductions: 

  1. The temporary rules apply to any expense paid or incurred after December 31, 2020, and before January 1, 2023, for food or beverages provided by a restaurant.
  1. The term “restaurant” means a retail business that “prepares and sells food or beverages for immediate consumption.” The food or beverages can be consumed on the restaurant’s premises, carried out, or delivered. However, a restaurant does not include a business that primarily sells pre-packaged food or beverages not for immediate consumption, like a grocery store or a vending machine.
  1. An employer may not treat an on-site eating facility as a restaurant under the temporary rules, either employer-operated or operated by a third party.

Those temporary rules are in addition to all the other rules that aren’t changing for 2021 and 2022, including:

  1. Business owners also need to be present for the meal and be engaged in conducting business activities. Alternatively, the business owner must be represented by an individual who is connected to the business, such as an employee or contractor.
  1. Meals cannot be lavish or extravagant under the circumstances. 
  1. As always, a documented record must be kept of the date, amount, business purpose and attendees at the meal.

Not simple at all. But it could be worth your time to learn about the temporary rules for deducting business meal expenses. It could double your business meal deduction! Need more details? The IRS has it for you here – https://www.irs.gov/pub/irs-drop/n-21-25.pdf.

Taxes for Married Couples in Businesses

Married couples who also operate a business together live a complex life. Commingling personal and business, experiencing 100% togetherness, is tough enough. Throwing taxes into the mix could be the straw that breaks the proverbial camel’s back and busts that togetherness apart. But it doesn’t have to be that way.

By default, according to the IRS, two or more individuals in business together without incorporating operate as a partnership. Partnerships are a complicated way to operate from a tax perspective. Partnerships file a separate income tax return, and each partner receives a Form K-1 to report for her or his pro-rata share of income and expenses, used to prepare the partner’s individual income tax return. Partners must also track the basis of partnership interest and any loans to or from the partnership, which impacts how distributions are taxed.

Married couples can get an exception to all those partnership complexities, if each spouse is an owner and materially participates in operating a business that is not formed as a Limited Liability Company (LLC). Instead of a partnership, spouses can elect to treat the business as a joint venture. The joint venture election breaks down to four simple steps:

  • Make the Qualified Joint Venture Election by filing a joint individual tax return. Spouses must consider profits and losses based on spouse’s interest and level of material participation in the business. Once the election is made, if the spouses receive an IRS notice asking for a partnership tax return, they should call or write to the IRS advising them of the qualified joint venture election.
  • Divide Profit and Loss between Spouses by dividing all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s level of material participation in the joint venture. The percentage allocation should be consistent for all items and reflect the relative percentage of participation. Allocations should be documented and updated for any changes in participation.
  • File Two Separate Business Schedules on the spouses’ individual income tax return. Each business schedule (i.e., IRS Schedule C or Schedule F) should be prepared with each spouse’s allocated share of income and expenses. The net profit or loss for the business schedules for each spouse is combined and reported on Form 1040, Schedule 1, Line 3. Net combined profit or loss is included in overall total income.
  • Report Net Profit as Self-Employment Income so each spouse’s earning from self-employment are credited and the applicable self-employment taxes are paid. Spouses who elect qualified joint venture status are treated as sole proprietors for federal tax purposes. A separate Schedule SE to report self-employment tax must be filed for each spouse to accurately report the net self-employment income.

Need more details about simplifying tax complexities when you are running a business as a married couple? The IRS has it for you here – https://www.irs.gov/businesses/small-businesses-self-employed/election-for-married-couples-unincorporated-businesses.

Residential Energy Tax Credits Extended

If you didn’t get all your home improvements done in 2020, and you think you missed out on some valuable residential energy tax credits, you’re in luck. Some renewable energy tax credits were extended. Others are still available at a lower rate. Even better, some tax credits were retroactively extended back to 2018. That could mean money back on your 2018, 2019, 2020, and, in some cases, your 2021 income tax liability.

Energy tax credits are an incentive for homeowners and builders to make energy-efficient improvements or upgrades that use less energy and protect the environment. For example, ENERGY STAR certified products are independently certified to use up to 30% less energy. Less energy use means a lower energy bill. It could also mean your lowering your taxes.

Here are six tips about Residential Energy Tax Credits:

  • Renewable energy tax credits are 22% of the cost for solar energy systems, fuel cells, small wind turbines, and geothermal heat pumps that are placed in service during 2021. Tax credit limits depend on the credit amount and your tax situation.
  • Residential Energy Property Tax Credits have been retroactively extended for qualified improvements from December 31, 2017, through December 31, 2021. These credits are generally 10% of the cost, up to $500, or a specific amount from $50-$300, depending on the improvement.
  • Improvements that qualify for the Residential Energy Property Tax Credit include qualified heat pumps, central air, boilers, furnaces, water heaters, circulating fans, and biomass stoves.
  • Qualified energy efficiency improvements that also qualify for a residential energy credit include energy-efficient insulation, metal and asphalt roofing, windows, doors, and skylights. The credit does not include the installation cost.
  • Energy credits apply to your newly-constructed or existing home that is used as your primary residence or your secondary home. These credits do not apply to rental properties.
  • You can take advantage of retroactively-extended energy tax credits by amending your federal income tax return up to three years after the original filing deadline (e.g., April 15, 2021, for a 2017 income tax return originally due April 15, 2018).

Home improvements that save on your energy costs could also lower your tax liability. Not only could 2020 improvements qualify for a tax credit, some of the qualified home improvements you made in the last three years could lower your prior-year tax liability, too. Want to know more? Check out the ENERGY STAR website https://www.energystar.gov/about/federal_tax_credits.

Don’t Miss Out on an EITC Refund

The Earned Income Tax Credit (EITC) was enacted back in the mid-1970s to assist low- and moderate-income workers. The EITC gives a financial boost to hard working people who can really use it. EITC can lower a working taxpayer’s tax liability, and even result in a refund that is bigger than the amount of federal taxes withheld. 

A tax credit like EITC is even better than a tax deduction. A credit is a dollar-for-dollar tax liability reduction, not a reduction of taxable income. For a worker in the 22% marginal tax bracket, a deduction means 22 cents less in tax where a credit means $1 less in taxes. Even better, the EITC is a refundable credit, meaning that the refund can be even more than the amount of income tax that was withheld or paid for the year.

Despite how large a financial boost it is, the IRS estimates that about 20% of eligible working taxpayers do not claim the EITC. Why? Because they don’t know about it.

Five important for workers to know about EITC:

  • To qualify for the EITC, the worker and everyone reported on her or his income tax return must have a valid Social Security number (SSN).
  • For 2020, workers may choose to use her or his 2019 earned income to figure the 2020 EITC if the 2019 earned income is more than the 2020 earned income. This opportunity to get a higher EITC is part of the Taxpayer Certainty and Disaster Relief Act of 2020. 
  • To qualify for the EITC, a worker must file a federal income tax return using the married filing jointly, head of household, single, or qualifying widow or widower. A worker cannot claim the EITC when using the married filing separately filing status.
  • Workers without a qualifying child are eligible for EITC by meeting the income rules, living in the U.S. for more than one-half of the year, not being claimed as a qualifying child on anyone else’s tax return, and being between the ages of 25 and 65 at the end of the tax year (usually Dec. 31).
  • Claiming the EITC could delay receiving a federal refund because of extra security checks performed by the IRS. 

The IRS wants hard working people who deserve a financial boost to know about EITC. The EITC can lower a working taxpayer’s tax liability to below zero, meaning that she or he could get a refund that is bigger than the amount of federal taxes withheld from her or his paycheck. Knowing about EITC can make a big difference in a person’s life.

Want to know more? Check out the details on the IRS website at https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit-eitc.