Wild Taxes Small Business Edition
On July 9th I had the pleasure of hosting The Wild Taxes Small Business Edition Zoom series with one of my good friends, Amber Carter (IG:@closewithcarter). We discussed tax strategies for small businesses including deductible business expenses, tax savings, and the Tax Cuts and Jobs Act. Part 2 of the series was hosted on July 23rd and covered tax implications for homeowners. If you weren't able to join, I've got you covered. See below for a recap. Stay tuned for a recap of Part 2 coming soon!
**The information in this post is intended to be general, not tax or legal advice. Always consult with your tax specialist or financial advisor prior to making any tax or financial decisions.
Business Structures
One of the first steps for small business owners is to determine an entity structure. The structure of your business will have many tax implications. There are 7 main entities that are most common for small business owners:
Sole Proprietorship - Easy to start, earnings are reported on schedule C, and there's no separation between personal/business assets. This entity structure is high risk due to personal liability.
Partnership - Must be two or more owners. There is shared liability but no separation between personal/business assets. This entity structure is considered a pass-through entity, meaning that earnings flow to the owner's tax return and there's no corporate taxation.
Limited Liability Company (LLC) - No personal liability. LLC's are pass-through entities and you can elect your tax status.
Single member LLC - Considered a disregarded entity and is taxed as a sole proprietorship. Earnings are reported on schedule C of an individual's personal tax return.
Multi member LLC - Taxed as a partnership. The entity files an information return on Form 1065 and provides a schedule K-1 to each partner.
Limited Liability Partnership - Similar to an LLC but a 2 shareholder minimum is required. No personal liability, but you still get the benefits of a pass-through entity.
C Corporation - No liability and easy to buy/sell shares. Corporations are not required to distribute annual earnings, but they are subject to double-taxation. Corporations must file form 1120 and must make quarterly tax payments. Distributions from a corporation are dividends and owners receive a 1099-DIV.
S Corporation - Similar to a C corporation. Not subject to double taxation, but more restrictions. Shareholders must be U.S. citizens and there is a 100 shareholder maximum.
Non-profit - Also called a 501(c)(3). Entity pays no taxes but Individuals who work for a non-profit or receive income from a nonprofit are subject to taxes.
Tax Implications for Small Businesses
Accurate accounting records – Maintain organization and accurate accounting records in order to be prepared for tax time. Utilize databases like excel and software like QuickBooks to help with keeping track of receipts and expenses.
Avoiding Fees and Fines – Obtain all appropriate licenses, permits, inspections, and registrations prior to starting your business. For example, in certain jurisdictions, renting out a room in your home requires a license and inspection. Some individuals move forward with business plans without obtaining proper licenses, which can become costly in the long run.
Make Timely Tax payments – Quarterly tax payments are required if income is expected to be greater than $1,000 ($500 or more for corps).
Changes Due to the Tax Cuts and Jobs Act
Exemptions – No more exemptions. Previously, individuals could take an additional $4,150 personal exemption for themselves and each dependent.
A married couple with 3 kids would have gotten a $20,750 deduction with 5 exemptions.
Under the new law there’s a $2,000 tax credit for all kids under 17, $500 for kids over 17 and phases out at $200k ($400k if married). Assuming the same couple has two kids under 17 and one kid over 17, they would get a $4,500 tax credit if they meet the maximum income requirement.
Standard Deduction – The deduction was previously $6,500 ($13,000 if married). For 2020 the standard deduction is now $12,400 ($24,800 if married).
State and local taxes – Limits the amount taxpayers can deduct to $10,000.
Qualified Business Income Deduction – Allows eligible taxpayers to deduct up to 20 percent of their qualified business income (QBI), plus 20 percent of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income. Generally, most businesses are qualified for this deduction. However, it does not apply to C corporations and the deduction phases out at $157,500 ($315,000 if married).
Expenses related to entertainment, amusement, and recreation are no longer deductible
Bonus Depreciation – 100% expensing for certain business assets.
Family Leave - IRS provides an employer credit for paid family leave.
Like-kind Exchange (Section 1031) - Allows certain taxpayers to avoid taxes on the exchange of similar business or investment properties. Section 1031 now only applies to exchanges of real property.
Deductible Business Expenses and Tax Savings
Fringe Benefits – A corporation can set up employee benefits and deduct the costs of running these programs, including all premiums paid. The employees, including you as the owner/shareholder, may also not pay taxes on the value of those benefits. Fringe benefits include dependent care expenses, educational assistance, health insurance, etc.
Outsourcing – Obtaining goods/services from an external party, especially in place of an internal source. Minimizes overhead and can be a great way to get expertise at a lower cost.
Equipment – Equipment can be deductible in the form of depreciation.
Mileage/travel - Maintaining a mileage log can save hundreds in taxes a year. Trips to buy materials, meet with a client, view new products, etc. can all be tax deductible.
Home Office Expenses – Can include Microsoft software licenses, equipment, laptops, iPad, phone bills, desk, license fees, permit fees. As long as the item is used in your trade/business it may be tax deductible!
Continuing professional education – Expenses for educational courses that improve your current skills or that are required by your employer to keep your salary can be tax deductible. Expenses to learn a new trade or job or to qualify for a new career aren't deductible.
Planning for the future
Offering retirement plans for your employees can have many benefits. Retirement contributions can supplement your compensation package. Additionally, corporations can set up employee matching plans and deduct the premiums paid on behalf of employees and the costs of running these programs.
401k – Contributions are made pretax, and taxes are taken out once distributed. Employers can make an additional contribution up to 25% of an individual's compensation.
Roth IRA – Contributions are made after-tax, but withdrawals are tax-free so earnings aren't taxed. Individuals can still participate in a Roth IRA plan even if they are still part of an employer sponsored health plan. Up to $6,000 yearly contribution maximum.
SEP IRA – Self-employed people or small-business owners with no or few employees are the most ideal candidates. No catch-up contribution available and distributions in retirement are taxed as income. A SEP IRA is easier to maintain than a 401k. There are no reporting requirements and contributions don't have to be made every year. However, employers must contribute an equal percentage of salary to each eligible employee. So if an owner gets a certain percentage match then all employees must receive the same.
Simple IRA – Best for larger businesses with up to 100 employees because it can get expensive with larger companies. $13,500 contribution limit in 2020. Contributions are pretax but distributions are taxed.
Defined Benefit Plan – Provides a guaranteed stream of income at retirement and is best for a self-employed person with no employees who wants to contribute a lot to their plan annually. The contribution limit is based on the benefit you’ll receive at retirement, your age, and expected investment returns. This plan can be expensive and difficult to maintain since an actuary will most likely be needed.