Understanding Taxes for Small Businesses Owned by Married Couples

Spouses joining forces in a business is a common foundation for entrepreneurial success, but the tax implications of these structures present a cascade of important decisions. The formation of a limited liability company (LLC) rains particularly complex circumstances upon unsuspecting couples. They should seek professional tax advice to avoid confronting unintended tax consequences.

Tax without an LLC

An LLC is created by registering with the state in which the business is organized. A business formed by one person without state registration is a sole proprietorship, and the individual owner is taxed on the business’s profit. Unregistered businesses formed by multiple individuals are automatically treated as partnerships. Profits from a partnership are reported on a separate tax return, but tax is assessed on the individual partners.

Spouses who begin businesses without state registration can escape the step of a partnership tax return. Instead, they may divide the business revenue and expenses on their joint tax return as if the enterprise was two separate sole proprietorships. Formation of an LLC upsets the ability to follow this tax-reporting shortcut, known as a qualified joint venture.

Spouses with an LLC

The IRS automatically treats an LLC formed by more than one person as a partnership. Consequently, spouses establishing an LLC together might discover that having this entity doesn’t deliver the desired federal tax arrangement. A partnership tax return is generally required.

As an exception to this general rule, the IRS will permit spouses operating an LLC in a community property state to enjoy tax reporting as a qualified joint venture. The LLC of spouses in a community property state is simply disregarded for federal income tax purposes.

Worth remembering is what happens upon the death of one spouse in an LLC. The survivor no longer has a spouse as a partner. Rather, the estate of the deceased spouse is the partner of the survivor. In a community property state, the LLC is no longer disregarded as a qualified joint venture. A partnership tax return generally becomes necessary. In most states that lack community property statutes, the surviving spouse simply has a different partner until the decedent’s estate is settled.

LLC Tax Elections

Any LLC may elect federal tax treatment as a corporation by the IRS. A corporation operates as an entity distinct from its owners. The business files a separate tax return and pays corporate income tax. The LLC members effectively become shareholders. They may also be compensated as employees of the corporation. Payments from the corporation to shareholders are dividends. Payments to employees, even if they are also shareholders, are wages. Dividends and wages are taxed differently. Moreover, the corporation receives a tax deduction for wages but not for dividends paid.

In contrast to regular corporations, S-corporations have made an additional election to have their shareholders personally taxed on business profits. Distributions of S-corporation profits to shareholders are not taxed as dividends. This avoids double taxation on payments from the corporation to shareholders. However, shareholders who work for their S-corporations must receive some compensation as wages. Wages incur payroll taxes. Clearly, careful planning is necessary to assure preferred results are secured when an LLC elects tax classification as a corporation.

Consider Current Year When Reporting Last Year’s Taxes

As the deadline passes for payment of income tax on last year’s income, immediate attention should be directed at addressing tax on income that’s being earned this year. The government imposes penalties when income tax is not remitted throughout the year. Although wage-earning employees satisfy this obligation through paycheck withholding, entrepreneurs are confronted with the duty of making their own calculations and sending estimated tax payments. The first of these payments for this year is due on the same date as the deadline for last year’s tax return.

This year’s estimated tax amounts are ideally determined from a projection of business income. This is easily identified if you prepared a current-year business budget. At the very least, projected income for this year can be derived from your taxable business income from last year. Simply identify whether you expect to generate more or less income than last year. A common expectation is that this year will be about the same. Your tax accountant can calculate estimated tax payments for this year based on the expected business income and your other income sources.

Two other methods for determining estimated tax installments are available. One is a complex form with your next tax return that shows your income during different periods throughout the year. Tax accountants can prepare it only if you maintain burdensome records. The other technique entails paying this year an amount of tax equivalent to last year. Even if you make substantially more income this year, you escape an underpayment penalty by making estimated tax payments your accountant identifies based on last year’s taxes.

Tax Rules for Reimbursing Employees Apply to Owners Too

If you were in charge of finance at a large international corporation, you wouldn’t give company money to an employee who merely asked for reimbursement of business expenses.

Instead, you would require the employee to provide substantiation of the expenses paid so you know what was purchased and the cost of every item.

As a small business owner, the same rules apply to reimbursements to you from your enterprise. In fact, the IRS requires that you deploy this process so that your business may obtain tax deductions for the reimbursed expenses.

This permits the company to deduct the amounts spent using the same expense categories as if the business had paid the vendors directly. Making this issue especially complex is the existence of special IRS rules for distinctive types of expenses.

Business Meals

You can slide a bit on keeping precise details about reimbursement for meals. The IRS requires substantiation for reimbursed business meals of at least $75. But you are wise to establish a much lower limit. This is particularly important for solo enterprises that are exposed to IRS questioning about business meal expenses comprising a substantial part of total expenses.

You can probably get by with not having every receipt for coffee you purchased for customers. But receipts are necessary to support claiming larger meals as business meals. Whether reimbursing yourself or employees, a sound practice is requiring receipts for any business meal of at least $25.

Meal receipts should include the name of the business associate for whom the meal was purchased. The business nature of the meal should also be documented, such as the general reason for meeting.

For very large meal costs, such as an entire table for many company attendees at a special event, a recommended policy is recording some details on the receipt. This can entail noting the name of the event sponsor and, in some cases, the name of the caterer.

When reimbursing for travel expenses, the amount for meals must be separated. Surely you do eat when traveling away from home for business, but only half of travel meal costs are tax-deductible, unlike a 100% deduction for travel transportation and lodging. And you cannot deduct any extra costs incurred to bring your spouse along on a trip that’s primarily for business.

Business Mileage

Both you and any employees should have a record of business miles driven with personal vehicles to qualify for reimbursement from the company. A mileage log for each trip will state the number of business miles driven, the location, and the general business purpose.

The reimbursement rate may be whatever you decide. However, the tax deduction cannot exceed more than the amount per mile that’s established by the IRS at least annually.

Business Gifts

Remember that the IRS does not allow a tax deduction for a business gift of over $25. Moreover, if you give a gift to an employee or contractor, many IRS rules are applicable. Most importantly, a gift card to anyone is considered cash compensation. The value of these must be added to the employee W-2 or contractor 1099. Your accountant can help identify other situations where this compensation standard applies.

Claiming Charitable Contributions as a Business Expense

As a general rule, contributions to a charity from your business are not considered business expenses. Only a regular corporation makes charitable contributions on its own behalf and takes a deduction for them from its taxable income. All other businesses do not pay income tax and pass through the tax impacts of their activities to their owners. Among the pass-through acts are gifts to charities.

Unincorporated sole proprietors, partners in partnerships, and shareholders of S corporations treat charitable contributions by their businesses as if they had made the donations themselves. The same rules apply to multiple-member LLCs when they’re taxed as either partnerships or S corporations. Part owners of organizations with multiple partners or shareholders receive a pass-through of business charitable contributions in proportion to their percentages of ownership. Business owners must itemize personal income tax deductions to receive tax benefits from charitable donations.

For the business to have a qualified charitable donation, a monetary cost must be incurred. Hence, no deduction is allowed for the value of an entrepreneur’s time or the time of employees for volunteering with a charity. The amount of deduction for donating a non-cash item is limited to its book value. This is the value not yet already deducted, including deducted depreciation expense. No business charitable contribution has occurred for giving an item whose cost has been fully depreciated or was deducted as an expense when purchased.

Payments to a charity can be counted as ordinary business expenses if they are directly related to business matters. This includes, for example, purchasing advertising from sponsorship of charitable events.

So … When Can I Deduct a Business Loss?

If you think a business loss can always be deducted on your income tax return, you might be in for a surprise. Beware that there are rules that limit this deduction. The bottom line is that the IRS insists taxpayers risk their own money in an enterprise when claiming a tax-deductible loss. Consider the following limits as you prepare to deduct a loss.

At-Risk Limit

At-risk limitations apply to individual sole proprietors, partners, and shareholders in S corporations. If your business has more allowable expenses than income, the excess money spent is limited from the deduction on your tax return. You must be losing your own money or borrowed funds that you are personally liable to repay.

Borrowing money from a friend or family member may result in business funds for which you are not at risk. To qualify as being at risk, any loan should have a formal promissory note that bears interest and has a specified due date for repayment.

Keep track of how much money you invest in your business. If you do have a deductible loss, it reduces the amount you still have at risk. Any money or other property you withdraw from your company for personal use decreases your at-risk amount.

A loss of other people’s money that is denied as a tax deduction carries over to subsequent years. That carryover loss can be deducted against future year profits.

Shareholder Basis Limit

Business owners of S corporations are confronted by an even greater burden known as the basis limitation.

Meticulous records for each shareholder are necessary to account for cash and property contributed to an S corporation. Added to these amounts is a shareholder’s proportional share of profit. The sum comprises the shareholder’s stock basis in the S corporation. But some of the profit is typically distributed to shareholders. These distributions reduce the stock basis.

Additionally, corporate profit for tax purposes is not profit in your bookkeeping. Some expenses paid by a business are not deductible on the income tax return. Nondeductible expenses reduce shareholder basis, just like distributions of profit.

Moreover, certain types of income and deductions are not included in an S corporation’s profit. Capital gains, for instance, retain their distinctive character and pass through to S corporation shareholders as a category of income that’s different from business profit. A Section 179 tax deduction is also separate from other business expenses. These and more are additions or subtractions from a shareholder basis.

Lastly, shareholders may loan money to their S corporations and establish “loan basis” as a different figure from stock basis. But loans are only valid when they bear interest. A minimal amount of interest must be calculated, even if it’s not being paid every year.

The upshot: losses triggering negative amounts of basis are nondeductible. This typically arises from borrowing to acquire fixed assets, such as machinery or equipment. When the cost of these items is rapidly deducted as depreciation, the business has a loss. But the loan still has an unpaid balance. The loss reduces shareholder basis.

Keep in mind that nondeductible losses carry over to future years. They are deducted when basis is restored by a shareholder’s cash investments or loans to the company or by future profit.

Discover the Secrets to Surviving Income Tax Reporting

Many business owners are concerned about paying their income tax liability, but far fewer are capable of accurately calculating their tax obligation. Although the burden of tax return preparation is best outsourced to professional accountants, entrepreneurs can take steps to ensure timely and thorough income tax reporting. After all, tax professionals can only know the financial details about your business that you convey to them.

Start by choosing a suitable system for maintaining your business records. This untangles the taxable events of an entire year. The use of technology is typically beneficial. Even a simple electronic spreadsheet of business revenue and expenses permits a computer to perform mathematical functions and minimize human error.

And this is far superior to a haphazard pile of receipts. The spreadsheet provides totals for annual revenue collected and amounts spent on each category of business expense.

Accounting software is even better because it balances revenue and expenses to cash sources, such as bank accounts and credit cards. This double-entry accounting system ensures you haven’t missed recording any transactions. However, professional assistance in knowing how double-entry bookkeeping works is crucial to obtaining accurate output from accounting software.

If you do have regular bookkeeping procedures, aim to examine and understand all the components that make up your financial statements. Go over any uncertainties with your bookkeeper to tie up loose ends.

Lastly, be at the starting line with your accountant to finish your tax return on time, obtain tax-related bookkeeping adjustments, and get suggestions for improvement in the year ahead.

Get Your 2019 Accounting Ready for Tax Time

Running a business entails so much work selling, delivering, and planning that precise financial tracking throughout the year is challenging. Despite having a sound bookkeeping system in place to facilitate judicious financial records, the process is unlikely to proceed without a hitch.

Most mistakes are a consequence of incomplete information when bookkeeping data entry is performed. Lost receipts or forgotten details about specific purchases are omissions any busy entrepreneur can experience. But the start of a new calendar year is the time to locate missing information and clean up the books before presenting them to your accountant for income tax return preparation.

Repair Financial Balances

Start with the business balance sheet. This report shows all the assets and liabilities of your business. These numbers correlate with the vital tax-related amounts of business profit and owner capital. Business owners can easily verify figures on the balance sheet for accounts with financial institutions by reconciling them to their account statements. Reconciling bank accounts and credit cards are standard bookkeeping procedures.

A frequently neglected area is fixed assets, such as machinery, equipment, buildings, and leasehold improvements to rented space. Not all amounts spent on equipment or a building should be added as fixed assets on the balance sheet. Some costs are low enough to expense as small tools or repairs. Your accountant can provide the income tax standards regarding which expenditures to categorize as fixed assets. Providing your bookkeeper with these rules permits easy year-end reclassification of amounts that might have earlier been misclassified as fixed assets.

Other areas to diagnose are accrued tax liabilities and long-term loans. Such liabilities as payroll taxes and sales tax should match remittances your business is scheduled to make. They are verifiable against records in other systems, such as payroll summary reports and sales reports.

Loan payments during the year include both interest and principal repayments. A loan history statement from the lender ensures all interest is deducted as an expense, with the remainder of payments applying to a loan account on the balance sheet.

Examine More than Profit

On the business income statement, make sure the correct amounts have been posted for payroll. One expense category should report total gross wages, not merely the sum of net paychecks. A different account covers the business part of payroll taxes. This excludes taxes withheld from employee pay, which are simply part of the gross wages.

Conduct a general cleanup of accounts. Combine accounts that duplicate the same expense category using slightly different names. Don’t have too much labeled as simply “miscellaneous” expenses. Determine the correct classifications for any entries in so-called suspense accounts with names such as “Ask Later.”

You should also provide your bookkeeper with information on any business expenses paid with personal money. These are recorded as if the business had paid for them directly.

Overall, make sure to identify and confirm the validity of every number on financial statements. Some accounts may have been created during the year for expediency pending more detailed information. Explanations to the bookkeeper about unclear transactions are a responsibility of the business owner. In other words, don’t leave your tax accountant wondering about mystery figures.

Start the New Year Right with a Review of Bank Reconciliation

The most important step an entrepreneur can take to ensure all revenue and expenses are recorded in the books is a reconciliation of the bookkeeping to bank records. Unexplained discrepancies between the cash balance on the books and the bank statements are a by-product of missing or inaccurate financial information. The result is questionable recorded profit.

After the prior year’s end, it is ideal to uncover legitimate reasons for the books to differ from a bank statement. A bank account on the balance sheet of your business from last month may show a different amount than last month’s bank statement. Some checks you’ve written may be outstanding, or deposits on the final day of the month might have been unprocessed when the bank statement was produced.

The reconciliation process locates previously missing transactions, such as bank charges, electronic remittances, and unrecorded deposits. But a business owner must scrutinize the reconciliation report to determine if further adjustments are needed.

Checks written long ago that have not yet cleared your bank account are known as stale checks. Any of these outstanding checks from more than a year ago should be removed from the business books with a journal entry dated in the current year. The business has ultimately not incurred these costs since the money never left the bank account.

The only deposits that should be missing from the bank statement are those you made at the end of the statement period. Older unreconciled deposits are indicative of errors or duplications and should be investigated.

Maintaining these current reconciliations will put you in a good position to start the year on solid financial footing.

Small-Business Financial Resolutions for the New Year

The approach of a new year inspires hopeful thoughts for the future. Topping the list is an eagerness for financial security, but achieving this requires more than abstract desire. Financial goals are only attainable when one constructs a workable design for the future. Despite uncertainties that may arise, commitment to a few indispensable actions can help your business thrive in the year ahead.

Start Early on Taxes

Perhaps the best protection against uncertainty is starting early on tax return completion. Tax season starts right after the middle of January. By the end of January, you have no excuses for not knowing prior year results.

A commitment to organized financial statements assures that tax return preparation work proceeds smoothly and is completed early.

Your accountant will likely have some annual bookkeeping adjustments for tax purposes. You only need to have the books in order that summarize ordinary day-to-day results of business operations. You should be aware of key elements such as total revenue, totals paid for each business expense category, and year-end asset and liability balances. Make sure your bookkeeper has enough information to reconcile the books to financial institution statements for bank accounts, credit cards, and loans.

Tax returns have deadlines. Long before the due date of your income tax return, you want to know the amount of any tax you owe.

Commit to Financial Evaluations

Maintaining reliable financial records throughout the year allows you to monitor business performance. Conducting regular self-analysis assures you’re on track for achieving your objectives. Be sure to plan for devoting time next year to recurring examination of business financial statements. This is the only path to quickly resolving any omissions or errors.

If you’re not sure how to interpret the business financial statements, professional accounting help is all you need. An accountant can summarize income from various products or services as well as describe where the money is being spent along with spending trends. Armed with this information, you can make optimal decisions about directing your time and other resources to maximize profit.

Reduce Business Expenses

A surefire way to increase business profit next year is to reduce expenses. Revenue can remain unchanged while the bottom line improves simply from lower costs. Resolving to save a fixed amount is too abstract. The better resolution is determining a precise expenditure target.

A cost-reduction goal may seem small, but it adds up over the course of a full year. Lowering a recurring monthly expense by $20 puts an extra $240 in your pocket. Since $20 isn’t much, select a few categories for this savings. Reducing the monthly cost for insurance, telephone, and internet by $20 each delivers a $720 annual savings. This means a lot to a small company. Even a large enterprise strives for this amount of profit increase, because it’s enough for a loan payment on a large amount for expansion or upgrades.

Completing your tax return early, committing to regularly scheduled financial statement examination, and continuously checking up on specific cost-reduction goals are resolutions to keep for success throughout the new year.

Two Quick Ways to Improve Business Cash Flow Next Year

Avoiding life’s negatives is generally a noble aim. And when it comes to cash flow, every business owner wants a positive outcome. Running low on cash signals trouble ahead. Judicious management of cash flow is more crucial to sustainable operations than generating new sales. After all, a business can survive slower revenue, but not without cash. The usual methods for enduring a cash crunch are establishing a line of credit, negotiating terms with vendors, and offering discounts for early-paying customers. Implementing a couple more creative measures, however, can result in permanent cash flow enhancements.

One important cash-saving procedure is timely remittance of taxes. Income tax payments in particular are supposed to be made in equal installments throughout the year. Penalties are assessed if you underpay the required estimated tax installments. Waiting to pay after year-end may mean parting with a surprisingly large chunk of cash. If you’re not sure how much taxable income to expect for the year, the IRS has a “safe harbor” formula based on your tax in the prior year. Your accountant can make this calculation, but doing so necessitates filing your tax return by the initial due date.

Another technique can improve cash flow for a business that receives recurring customer payments, such as contract work. This is accomplished with direct electronic payment using the Automated Clearing House (ACH). ACH transactions may be established with your customers to push funds directly to your bank account. Similarly, an ACH direct debit arrangement permits your bank to pull funds from a customer for preauthorized amounts. These methods eliminate invoicing and waiting for payment. The result: faster cash flow and a better bottom line.