Do You Own a Specified Service Trade or Business? If So, Your 20% Pass-Through Tax Deduction May Be Limited

As part of its recent tax reform, Congress included a new 20% deduction of pass-through income for trades or businesses other than C-corporations. This pass-through income is referred to as qualified business income (QBI); for trades or businesses, it generally includes bottom-line profits, and for S-corporations and partnerships, it includes K-1 flow-through income. This new law was added as tax code section 199A, so the deduction is often referred to as the 199A deduction.

Congress added this deduction to benefit sole proprietors, partners, and S-corporation shareholders (among others); the goal is to allow for benefits equivalent to the substantial tax-rate cut that the same reform provided to C-corporations. However, this new deduction is not applied uniformly to all types of trades and businesses, for which there are two categories:

  • qualified trades or businesses (QTBs) and
  • specified service trades or businesses (SSTBs).

This deduction is limited by the taxpayer’s filing status and 1040 taxable income, and it differs depending on whether the business is a QTB or a SSTB. Although the main purposes of this article are to define SSTBs and to describe how they are taxed differently from QTBs, if one is to understand why an SSTB may not qualify for the deduction, whereas a QTB might qualify, it is necessary to first understand the basic differences between the deductions for SSTBs and QTBs.

Apparently, Congress considered the income from service businesses to be akin to wages and didn’t want taxpayers who provide services to have the benefit of the 20% deduction instead of paying taxes on that income as ordinary wages. This change was primarily aimed at deterring high-income people from becoming independent contractors or setting up pass-through businesses so that they could turn their wages into business income and get the 20% deduction. The result is a phase-out of the deduction for high-income taxpayers who have income from SSTBs.

The table below provides an overview of the tax treatment for each type of business. As you will note, the SSTB deduction phases out for higher levels of 1040 taxable income, but the QTB deduction does not. This type of phase-out is called a wage limitation.

Example of How to Use the Table: Two married people who are filing jointly have 1040 taxable income (before the 199A deduction) of $469,000; they also have a SSTB. They would first select the box with their filing status (“Married Filing a Joint Return”), then move to the right to the correct range of 1040 taxable income (which is the adjusted gross income after removing either the standard deduction or the itemized deductions; in this case, “Greater than $415,000”), and finally follow that column down to the cell aligned with the correct type of business (“SSTB”). In this case, the trade or business does not qualify for the 199A deduction.

Taxpayer’s Filing Status

Taxable Income
(Before the 199A deduction)

Married Filing a Joint Return
Less Than $315,000
Between $315,000 and $415,000

Greater than $415,000

Other filing Statuses
Less Than $157,500
Between $157,500 and $207,500

Greater than $207,500

Type of Business
The 199A Deduction
SSTB
20% of QBI
Deduction phased out
No deduction allowed
QTB
20% of QBI
Wage limitation phased in
Deduction equal to the lesser of 20% of QBI or the wage limitation

Specified Service Trades or Businesses (SSTBs)
The IRS describes SSTBs as being in the following fields:

  • Health – The health category includes the provision of services by physicians, pharmacists, nurses, dentists, veterinarians, physical therapists, psychologists, and similar health care professionals who provide medical services directly to patients. However, this excludes the provision of services that are not directly related to a medical field, even when those services purportedly relate to the health of the service recipient. For example, this category excludes the operation of health clubs or spas that provide physical exercise or conditioning; health-related payment processing; or the research, testing, manufacture, and/or sales of pharmaceuticals or medical devices.
  • Law – The law category refers to the provision of services by lawyers, paralegals, legal arbitrators, mediators, and similar professionals in their capacities as such. The category excludes the provision of services that do not require skills unique to the field of law, such as the printing, delivery, and stenography services provided to lawyers.
  • Accounting – The accounting category includes the provision of services by accountants, enrolled agents, tax-return preparers, financial auditors, and similar professionals in their capacities as such. This category is not limited to services that require state licensure as a certified public accountant. This category also excludes payment processing and billing analysis.
  • Actuarial Science – The actuarial science category refers to the provision of services by actuaries and similar professionals in their capacities as such. This category only includes the services provided by analysts, economists, mathematicians, and statisticians if they are engaged in analyzing or assessing financial costs due to risk or uncertainty.
  • Performing Arts – The performing arts category includes the performance of services by individuals who participate in the creation of the performing arts, including actors, singers, musicians, entertainers, directors, and similar professionals in their capacities as such. It excludes services that do not require skills that are unique to the creation of performing arts, such as the maintenance and operation of equipment or facilities. Similarly, the dissemination of video or audio of performing-arts events to the public is not considered to be a service in the performing arts.
  • Athletics – The athletics category refers to the performance of services by individuals who participate in athletic competitions, including athletes, coaches, and team managers in sports such as baseball, basketball, football, soccer, hockey, martial arts, boxing, bowling, tennis, golf, skiing, snowboarding, track and field, billiards, and racing. This category excludes the provision of services that do not require skills that are unique to athletic competition, such as the maintenance and operation of equipment or facilities for use in athletic events. It also excludes the provision of services by persons who disseminate video or audio of athletic events to the public.
  • Consulting – The consulting category refers to the provision of professional advice and counsel to clients to assist them in achieving goals and solving problems. Consulting professionals include lobbyists and similar professionals, but this category focuses on their capacities as such and excludes the minor consulting that accompanies the sale of a product. A trade or businesses cannot be an SSTP if less than 10% of its gross receipts are from consulting (or 5% if the company’s gross receipts are greater than $25 million).
  • Financial services – The category of financial services applies to services that are typically performed by financial advisors and investment bankers, including the following financial services: managing wealth; advising clients with respect to their finances; developing retirement and wealth-transition plans; providing advisory and other services regarding valuations, mergers, acquisitions, dispositions, and restructurings (including in title 11 bankruptcies and similar cases); and raising financial capital through underwriting or by acting as a client’s agent in the issuance of securities. This includes the services provided by financial advisors, investment bankers, wealth planners, retirement advisors, and similar professionals but excludes banking services such as deposit-taking or loan-making.
  • Brokerage Services – The brokerage services category includes services in which a person arranges transactions between a buyer and a seller with respect to securities and in exchange for a commission or fee. This includes services provided by stock brokers and similar professionals but excludes services provided by real estate or insurance agents and brokers.
  • Reputation or Skill – The original legislation’s list of SSTBs included trades or businesses for which the principal asset was the reputation or skill of one or more of employees or owners. However, it was unclear if this meant, for example, that a self-employed plumber who provided his skill to the business would be eligible for the 199A deduction. The taxpayer-friendly interpretation of these tax regulations has generally defined “reputation and skill” to mean:(1) The receipt of income in exchange for endorsing products or services for which the individual provides endorsement services;
    (2) The receipt of licensing income in exchange for the use of an individual’s image, likeness, name, signature, voice, trademark, or any other symbol associated with that individual’s identity; or
    (3) The receipt of appearance fees or income (including fees or income paid to reality performers who appear as themselves on television, social media, or other forums; radio, television, and other media hosts; and video game players).

The amount of pass-through deduction that is ultimately available due to an SSTB is entirely dependent upon the taxpayer’s 1040 taxable income. Thus, in some cases, pension contributions and the expensing of business assets can lower a taxpayer’s taxable income enough that he or she benefits from an increase in the pass-through deduction. In this scenario, married couples who are not living in community-property states could benefit from filing separately rather than jointly.

If you have questions related to whether your business qualifies for this new deduction, whether it is classified as an SSTB, or how SSTB income fits into your overall tax picture, please give us a call.

After Tax Reform, Which Is Right for You: S Corp or C Corp?

The Tax Cuts and Jobs Act has left many of today’s businesses with big questions. Incorporation remains a hot topic, but this law is shaking things up. It’s quick to assume your company should be one or the other, but without careful consideration of the facts, your organization may end up facing financial loss, hefty tax penalties or missed tax savings.

The goal of this type of incorporation is to minimize tax burdens, but the wrong decision can be costly. In a C Corp, the company pays corporate taxes to the Internal Revenue Service. But, in an S Corp, there’s no entity tax. Rather, taxes are paid through an individual return.

The New Law Changes
The new law, which went into effect for the 2018 tax year, brought changes to both S Corp and C Corp businesses. In fact, both types of corporations benefited here. For C Corps, the tax rate was dropped from 35 percent down to just 21 percent. For an S Corp the new law provides a deduction equal to 20% of the pass-through income from the corp subject to limitations for higher-income taxpayers. At best, this reduces the effective tax rate to 29.6 percent from 37 percent. In both cases, there are specific restrictions here to know.

One thing to remember about these tax changes is that there are many components to determining which method is right for your business. Don’t make a quick judgment here. Rather, invest in some one-on-one time with your tax professional to determine the best possible scenario for your individual company. To help, consider these key areas.

S Corp and C Corp Ownership
A key component in deciding how to incorporate your business relates to ownership. In the S Corp, there is a limit of 100 shareholders within the company. These must be domestic organizations operated in the United States where all of the company’s shareholders are also living in the United States. Additionally, this structure allows for a single stock classification. As a business, you cannot offer common stocks as well as preferred shares, for example.

Comparatively, C Corps allow for fewer restrictions. There is no limit on ownership at all. There is no limit on the number of shareholders the company can have. Any small- to a medium-sized company planning an IPO or simply obtain investors outside of the traditional domestic structure will find C Corps offer far more flexibility.

Another key factor about C Corps relates to the differences within your shareholders. These corporations can issue several types of stock. As a result, it is not uncommon for some shareholder votes to be more important than others. This, too, can influence the decision you make in choosing one or the other model.

Corporation Taxation – Choosing the Best Taxation Structure
Most companies will focus most of their decision on S Corp or C Corp options based on ownership as a starting point. However, every company also wants to keep costs low. Taxation is one of the most expensive hurdles any organization must manage. And, each type of structure offers a different look.

For example, consider how a C Corp is taxed. It is commonly referred to as a “double taxation structure.” This is because the company (the entity itself) will pay a corporate tax. Then, the stockholders pay taxes on their income from the business. While this has long been a concern for any business owner using the C Corp structure (paying taxes twice on income is very costly), the new tax law changes this a bit. As noted previously, the tax rate for C Corp has changed from 35 percent to just 21 percent. However, the dividends will still be faced with double taxation.

The slashing to 21 percent means every company is paying the same rate, neither the size of the company nor the type of organization matters. That’s an important consideration when choosing which type of structure is right for your company.

With the help of a tax professional, it is also important to consider other tax strategies available. For example, an S Corp shareholder pays taxes every year on the money the company earns during that year. This is a simpler, straightforward scenario. But, in a C Corp, the taxes are only paid when the company decides to distribute dividends. It can also occur if a shareholder realizes capital gains (such as when selling ownership). This provides the C Corp with an ability to minimize taxes just by timing dividends properly.

Making the Right Decision for Your Needs
This is only the very top edge of considerations for which is best for your company. However, there are a few things that can influence your decision.

Stable Small Businesses
If you own a smaller company, you’ll benefit from an S Corporation for various reasons. First, the income passes through and is taxable to the stockholders on their 1040s, thereby eliminating double taxation. Plus the lower tax rate and the 20% pass-through deduction are very beneficial to an S-Corporation structure.

Growing Small Businesses
If your company is growing – or you plan to go public and take on new ownership, the C Corporation offers the opportunity to do so. It allows for a larger number of investors, and international investments are possible. Additionally, as a smaller business, you may not be likely to issue dividends any time soon. As a result, this can reduce the amount of income reported to the IRS on an annual basis.

Larger Companies
For larger organizations, the C Corp tends to offer the best structure overall. Other options limit investor access and may create scenarios where the company cannot grow. The effective tax rate is significantly lower – competitive to any company no matter the size. The new tax reform provides the most advantages to this buyer in particular.

Making the Decision for Your Needs
Many organizations today have jumped on the new tax reform as an opportunity to incorporate more tax savings. However, a clear picture is important and we recommend slowing down before making any type of drastic decisions like this. They have far-reaching implications and can create a financial burden or limitations on an organization if the wrong decision occurs. With the assistance of a tax professional or attorney, it is possible to make better decisions based specifically on the type of business structure you have, the business’s short-term and long-term goals, as well as new laws and taxation rates. Before you make a change as an entrepreneur, know what you are really getting. Please contact us with any questions.

10 Mistakes Most Small Business Owners Miss When Starting Out

The process of starting a small business can be an arduous one; there are numerous steps that need to be taken — and often in a precise order — to legally establish a business. As a result, the process can be overwhelming. Unfortunately, it’s also easy to overlook some important details and steps along the way. By being aware of a few of the most common legal and compliance mistakes made by small business owners when starting out, you can be better prepared for future success.

1. Misclassifying Employees as Independent Contractors
Regulators are coming down hard on misclassifications. The IRS estimates that this problem includes millions of workers. It is best to talk this through with an expert, but you can get some background on the guidelines at the United States Department of Labor website.

2. Choosing the Wrong Business Structure
One of the first major decisions you’ll need to make in regards to your small business is the type of business structure you will select. This can range anywhere from a basic sole proprietorship (which doesn’t require any special forms or paperwork) to a more complex structure, such as a corporation or LLC. Keep in mind that different types of business structures offer different tax benefits and other protections, so it’s important to thoroughly explore your options and select the structure that’s best for your unique needs. You’ll also need to go through the legal process of establishing your business under your desired structure, which may require help from a legal or other type of professional.

3. Failing to Apply for an Employer Identification Number
Unless you plan on operating your business strictly as a sole proprietorship (in which case, you will use your personal Social Security number when filing taxes), you’ll also need to apply for a unique Employer Identification Number (EIN). This number will be specifically associated with your business, and it can be helpful to think of it as a business Social Security number of sorts; it’s used to file your business taxes, open up dedicated business bank accounts, and the like.

4. Overlooking Important Permits and Licenses
Depending on the specific industry in which your business will be operating and your location, you may also be required to obtain specialized licenses and/or permits in order to legally operate. Otherwise, you’ll run the risk of being shut down or finding yourself in serious legal trouble down the road. Take some time to research the specific types of permits or licenses that you may need to obtain, as well as the steps you’ll need to take in order to acquire them. Sometimes, this process can be time-consuming and even costly, so it’s not something you’ll want to put off until the last minute.

5. Not Knowing When to Speak to a Professional
When starting up a small business, it’s not uncommon to run a one-man (or woman) operation. After all, you may not have the cash flow or even the need to hire outside help in the early stages. Still, when it comes to making sure your business is squared away from a legal/compliance standpoint, it can certainly be worth the money to consult with tax and accounting professionals early in the game. You don’t necessarily need to onboard these experts full-time, but being able to turn to them for advice and guidance when you need it will help you avoid serious legal issues later on.

6. Putting Off Domain Name Registration
As soon as you have your business name picked out and registered, it’s also in your best interest to go ahead and register your website domain as soon as possible. Even if you don’t plan on setting up and launching your website any time soon, domain names are cheap, and having yours registered now will help you avoid a situation where the domain name you want is taken by somebody else later on.

7. Lack of a Comprehensive Business Plan
One of the biggest mistakes small business owners make when first starting out is that of not having a well thought-out and articulated business plan. A business plan is an important document that outlines in detail what your goals for your business are and how you will achieve them. This document is important not just for you and other members of your immediate team, but for potential investors as well. Should you seek financing for your company at any point, an investor is going to want to see and scrutinize your business plan — and it will likely have a major impact on the final decision.

8. Not Having Finances Squared Away
Another common mistake new business owners make is that of poor financial planning, which can lead to a lack of funding to get you through your first months successfully. Ideally, you’ll want to make sure your business plan accounts for all the company-related expenses you’ll incur during the first year of operation, as well as any personal expenses as well. Unfortunately, this is something that many small business owners overlook or miscalculate with disastrous results. The easiest way to avoid this mistake is to consult with a small business accountant during the early stages of drafting your business plan.

9. Failing to File Patents on Products or Ideas
It’s (hopefully) no surprise that you’ll want to be proactive about filing for patents for any unique products, prototypes or designs you may have. However, what many small business owners first starting out don’t realize is that they’ll also want to file patents on ideas, such as intellectual property, that could otherwise be stolen or copied and used by other entrepreneurs. After all, intellectual property can be just as valuable as a product prototype — so you’ll want to plan and protect these kinds of ideas accordingly.

Be careful to also avoid the mistake of waiting too long to file for relevant patents; the process can often be long and drawn out, so getting started as early as possible will be in your best interest.

10. Being Blind to Important Compliance Requirements
Last, but not least, make sure you’re aware of any and all compliance requirements that may apply to your business based on its structure, location, industry or other factors. For example, even if you’re keeping things “simple” by operating as a sole proprietorship, you’re going to be required to file and pay quarterly estimated taxes under that structure. Failing to meet compliance and other requirements can result in serious legal trouble, including fines and penalties, down the road.

When it comes to compliance requirements, such as annual reporting and tax filing, it’s always a good idea to keep a calendar of important dates, so you don’t forget anything. After all, you’ll have enough deadlines to worry about and remember on your own — especially during that first year of business operation. This is yet another situation where having a compliance expert, such as a tax or accounting professional, can really come in handy. He or she can assist you with annual compliance reviews, reminders on impending deadlines and the like.

From selecting a name and business structure to making sure your small business remains in compliance at all times, there are, unfortunately, a lot of opportunities to make mistakes as a new business owner. By keeping this information in mind and by working alongside the right types of professionals as you prepare to launch your new business, hopefully, you’ll be able to avoid these issues. From there, you can maximize your chances for success in the first year of operation and beyond.

How Some High-Income Taxpayers Can Maximize the New 20% Pass-through Business Deduction

Taxpayers with higher 1040 taxable incomes who are self-employed but are not “specified service businesses” may find it beneficial to structure new businesses, or restructure an existing business, as an S corporation to avoid taxable income limitations that apply to the new 20% Sec. 199A pass-through deduction.

To make up for the tax reform’s reduction of the C corporation tax rate to 21%, from which other forms of business activities do not benefit, Congress created a new deduction and code section: 199A. The 199A deduction is for taxpayers with other business activities – such as sole proprietorships, rentals, partnerships and S corporations – since, unlike C corporations, which are directly taxed on their profits, the income from the other business activities flows through to the owner’s tax return and is taxed at the individual level, i.e., at the individual’s tax rate, which can be as high as 37%.

This new Sec. 199A deduction is 20% of the pass-through income from these business activities. But not every owner of these flow-through businesses will benefit from this deduction because, as in all things tax, there are limitations.

Whether or not a taxpayer will benefit from the deduction will depend in great part upon the taxpayer’s 1040 taxable income figured without the Sec. 199A deduction. Married taxpayers with a taxable income below $315,000 (or below $157,500, for others) will benefit from the full 20% deduction.

However, limitations begin to apply when a taxpayer’s 1040 taxable income exceeds those amounts. The most restrictive limitation is the one placed on “specified service businesses.” Once married taxpayers filing jointly have a 1040 taxable income exceeding $415,000 (or above $207,500, for others), they receive no Sec 199A deduction benefit from any pass-through income derived from a specified service business. Specified service businesses include trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services or any trade or business in which the principal asset of the trade or business is the reputation or skill of one or more of its employees or owners. Note that an engineering or architecture business is not a specified service business for this deduction.

On the other hand, a taxpayer can still benefit from pass-through income from other business activities, even when the taxpayer’s 1040 taxable income exceeds the $415,000/$207,500 limits, provided the business activity pays wages and/or has qualified business property, the combination of which make up what is referred to as the wage limitation. Without getting too complicated, the Sec. 199A deduction is the lesser of 20% of one’s pass-through income or the wage limitation. If the wage limit is zero, then the Sec. 199A deduction would also be zero for these high-income taxpayers. The wage limitation itself is the greater of 50% of the wages paid by the business activity or 25% of the wages paid plus 2.5% of the cost of qualified business property. Perhaps this is best explained by example.

Example #1: Peter and his wife have a 1040 taxable income of $475,000. Peter has a self-employed business (not a specified service business), from which he has a net profit of $300,000, and his tentative 199A deduction is $60,000 (20% of $300,000). However, because his taxable income exceeds $415,000, his Sec. 199A deduction is the lesser of $60,000 or the wage limit. Peter has no employees or qualified business property, so his wage limitation is zero; thus, his Sec. 199A deduction is also zero.

Example #2: Same as example #1, except Peter’s business is organized as an S corporation. Of his net profit of $300,000, it is determined that a reasonable compensation (wage) for the services Peter provides to the S corporation is $150,000, which the S Corporation pays as a salary to Peter. The other $150,000 is pass-through income. Now, Peter’s Sec. 199A deduction is the lesser of 20% of the pass-through income – $30,000 (20% of $150,000) – or the wage limitation, which is 50% of the wages paid by the S Corporation or $75,000 (50% of $150,000).

This demonstrates how a business activity can benefit from being organized as an S corporation, since S corporations are required to pay working shareholders a reasonable wage for their services provided in operating the business. They are able to divide the pass-through income between reasonable wages and pass-through income to enable a 199A deduction for a higher-income taxpayer. Other business entities do not provide this option, which is the reason why high-taxable-income taxpayers might explore the benefits of organizing new businesses as, or reorganizing their existing businesses into, an S corporation.

Of course, there are other issues involved as well, and some sole proprietors may not find it worth the expense or effort to switch to a different type of business entity. However, the higher the taxpayer’s income, the more beneficial it becomes. The same issues also apply to partnerships. To see if organizing or reorganizing your business activity into an S corporation can reduce your tax liability, call us for an appointment.


Tax Reform Puts a Cap on Deducting Business Losses

Note: This is one of a series of articles explaining how the various tax changes in the GOP’s Tax Cuts & Jobs Act (referred to as “the Act” in this article), which passed in late December of 2017, could affect you and your family, both in 2018 and future years. This series offers strategies that you can employ to reduce your tax liability under the new law.

Under the Act, deductible business losses of noncorporate taxpayers will be limited beginning in 2018. Many have misconstrued this new law to mean that no losses are allowed.

Fortunately, that is not the case. The Act does not allow “excess business losses” to be deducted. An “excess business loss” is the excess of the taxpayer’s aggregate trade or business deductions for the tax year (determined without regard to whether the deductions are disallowed for that tax year) over the sum of the taxpayer’s aggregate gross income or gain for the tax year from those trades or businesses, plus $250,000 (200% of that amount for a joint return (i.e., $500,000)). This amount will be adjusted for inflation after 2018.

More simply put, deductible losses for the year are generally limited to $250,000 ($500,000 for married couples filing jointly).

Example: A single taxpayer, in 2018, has two businesses. The combined deductions from the two businesses total $500,000. The taxpayer’s gross income from those two businesses is $200,000. After netting the income and deductions, there is a net loss of $300,000 ($200,000 – $500,000). Prior to the Act, the deductible loss would have been $300,000. However, under the Act the excess business loss is equal to $50,000 ($500,000 – ($200,000 + $250,000)). And since excess business losses are not deductible, the taxpayer can only deduct $250,000 ($300,000 – $50,000) in 2018.
On the bright side, the nondeductible excess business loss ($50,000 in our example) is treated as a net operating loss (NOL) carried forward to the next year’s return, where it is deductible from the taxpayer’s gross income, including nonbusiness income. Under the Act, an NOL is carried forward indefinitely until it is used up. The Act did, however, limit NOLs in the future to offsetting only 80% of a taxpayer’s income for any year.

If you have questions related to “excess business loss,” please give us a call.

First-Year Start-Up Tax Issues

If creating a start-up business were an easy thing to do, then a lot more people would be doing it. For those who make the decision to fulfill their dreams and go for it, success relies on being fully prepared. Some of the most common stressors encountered by entrepreneurs involve tax liabilities, whether business is booming or they’re struggling to keep their head above water. The best way to avoid these pitfalls is to learn about them ahead of time. Here’s what every entrepreneur needs to know.

Give Careful Consideration to the Type of Business Organization You Choose
The entity that you choose for your start-up will have a big impact on how your taxes are handled, so make sure you’ve done your research to find the option that works best for your specific situation. Factors like the state where you’re doing business and the type of business you’re operating will be a consideration, and so will your ownership profile. Businesses that don’t plan on adding partners or shareholders in the future or that anticipate changing owners in the near future are probably limited to establishing as a C corporation or an S corporation, with the former offering more flexibility on ownership shifts, as well as the possibility of international investors.

Though there’s no law to prevent you from shifting to another type of entity in the future, doing so can be disruptive, so it makes sense to take your time and choose the option that fits best and makes the most sense based on your current ownership plans.

Choosing an Accounting Method
Unless you’re an accountant or have experience and significant knowledge of accounting, it’s a good idea to sit down with a professional to determine whether you’re going to use a cash accounting method, an accrual method, or a hybrid of the two. If you don’t have a background in bookkeeping and taxes, it may seem like an academic question, but it plays a big part in determining your tax liability. A lot of the determination will also depend on the type of business you run. An experienced accountant will be able to walk you through the decision that makes the most sense and that will be easiest to implement in compliance with IRS regulations.

Putting Internal Controls in Place
As a start-up, there are certain internal controls you need to put in place to ensure that your business is running smoothly and according to your stated objectives and goals. You also want to be sure that you’re set up to provide comprehensive information for external investors. Company policies need to be written and communicated with an eye to regulations. A CPA will be invaluable in helping you get these controls in place.

Paying Attention to Compliance
Every entrepreneur likes to do things their own way, but there are some issues where compliance is key. Failure to follow the rules and regulations could lead to stiff penalties and fines, or even to your business either temporarily or permanently being shut down. In addition to paying taxes on your business’s income, you also need to find out whether your locale requires a business license and what the rules are if you’re selling either a digital or physical product over state lines. Sales tax will need to be paid, workers’ compensation insurance will need to be purchased and a policy put in place if you have even a single employee, and if you’ve organized yourself as a Delaware corporation, then you’ll need to have an annual franchise tax report prepared, filed and paid, whether you generate income or not.

Creating a Way to Track Performance and Stay on Budget
One of the biggest mistakes new business owners make is failing to create a budget and stick to it. Failure to do so can easily lead to a shortfall in available funds, including those you need to pay your tax liability. Take the time to make a reasonable budget and establish what your start-up’s key performance indicators (KPIs) are for both cutting expenses and generating income. With those issues addressed, you give yourself a solid way to measure how you’re doing, and you’re likely to find both short-term and long-term tax planning easier too.

Starting a new business is a dream come true for many, but your focus has to go beyond your own area of expertise and interest. By working with a tax professional, you can be sure that you’ve addressed the tax-related problems that have tripped up many start-up organizations.

Please call us with any questions related to creating a start-up business.

Five QuickBooks Reports You Need to Run in January

Does your accounting to-do list look like a clean slate, or are critical 2017 tasks still nagging?

Getting all of your accounting tasks done in December is always a challenge. In addition to the vacation time you and your employees may have taken over the holidays, there year-end projects.

How did you do last month? Were you ready to move forward when you got back to the office in January? Or did you run out of time and have to leave some accounting chores undone?

Besides paying bills and chasing payments, submitting taxes and counting inventory in December, there’s another item that should have been on your to-do list: creating end-of-year reports. If you didn’t get this done, it’s not too late. It’s important to have this information as you begin the New Year. QuickBooks can provide it.

A Report Dashboard
You may be using the Reports menu to access the pre-built frameworks that QuickBooks offers. Have you ever explored the Report Center, though? You can get there by clicking Reports in the navigation toolbar or Reports | Report Center on the drop-down menu at the top of the screen.

QuickBooks’ Report Center introduces you to all of the software’s report templates and helps you access them quickly.

As you can see in the image above, the Report Center divides QuickBooks’ reports into categories and displays samples of each. Click on one of the tabs at the top if you want to:
  • Memorize a report using any customization you applied.
  • Designate a report as a Favorite.
  • See a list of the most Recent reports you ran.
  • Explore reports beyond those included with QuickBooks, Contributed by Intuit or other parties.

Recommended Reports
Here are the reports we think you should run as soon as possible if you didn’t have a chance to in December:

Budget vs Actual
We hope that by now you’ve at least started to create a budget for 2018. If not, the best way to begin is by looking at how close you came to your numbers in 2017. QuickBooks actually offers four budget-related reports, but Budget vs Actual is the most important; it tells you how your actual income and expenses compare to what was budgeted.

Budget Overview is just what it sounds like: a comprehensive accounting of your budget for a given period. Profit & Loss Budget Performance is similar to Budget vs Actual. It compares actual to budget amounts for the month, fiscal year-to-date, and annual. Budget vs Actual Graph provides a visual representation of your income and expenses, giving you a quick look at whether you were over or under budget during specific periods.

Income & Expense Graph
You’ve probably been watching your income and expenses all year in one way or another. But you need to look at the whole year in total to see where you stand. This graph shows you both how income compares to expenses and what the largest sources of each are. It doesn’t have the wealth of customization options that other reports due, but you can view it by date, account, customer, and class.

A/R Aging Detail

QuickBooks’ report templates offer generous customization options.

Which customers still owe you money from 2017? How much? How far past the due date are they? This is a report you should be running frequently throughout the year. Right now, though, you want to clean up all of the open invoices from 2017. A/R Aging Detail will show you who is current and who is 31-60, 61-90, and 91+ days old. You might consider sending Statements to those customers who are way past due.

A/P Aging Detail
Are you current on all of your bills? If so, this report will tell you so. If some bills slipped through the cracks in December, contact your vendors to let them know you’re on it.

Sales by Item Detail
January is a good time to take a good look at what sold and what didn’t in 2017 before you start placing orders for 2018. We hope you’re watching this closely throughout the year, but looking at monthly and annual totals will help you identify trends – as well as winners and losers.

QuickBooks offers some reports in the Company & Financial and Accountant & Taxes categories that you can create, but which really require expert analysis. These include Balance Sheet, Trial Balance, and Statement of Cash Flows. You need the insight they can offer on at least a quarterly basis, if not monthly. Connect with us, and we can set-up a schedule to look at these reports. If you have any QuickBooks questions, or would like any assistance, please contact us.

Driving For Uber Or Others? Your Tax Situation Is Unique

With tax time approaching, if you drive for Uber, Lyft or a competitor, here is some tax information related to reporting your income. You are considered self-employed and will report your income and deductible expenses on IRS Schedule C to arrive at your taxable income for income tax and self-employment tax.

Your driving income will be reported on IRS information Form 1099-K, which reflects the entire amount for your fares charged on credit cards through the Uber reporting system. So if the 1099-K includes the total charges, then it also includes the Uber fee and credit card fees, both of which are deductible by you on your Schedule C. To determine the amount of those fees, you must first add up all the direct deposits made by Uber to your bank account. Then subtract the total deposits from the amount on the 1099-K; the result will be the total of the Uber fees and credit card processing fees. If you drive for multiple services, you will have multiple 1099-Ks and deposits from multiple services. It is highly recommended that you keep copies of your bank statements for the year so you can verify deposits in case of an IRS audit.

You will also need to include in your income any cash tips you received that were not charged through Uber. You should keep a notebook in your vehicle where you can record your cash tips. Having a contemporaneously maintained tip logbook is important in case of an audit.

Your largest deduction on your Schedule C will be your vehicle expenses. The first step in determining the deduction for the business use of a vehicle is to determine the total miles the vehicle was driven, and then, of the total miles, the number of deductible business miles and non-deductible personal miles. Recording the vehicle’s odometer reading at the beginning of the year and again at year-end will give you the information needed to figure total miles driven during the year. Although the Uber reporting system provides you with the total fare miles, it does not include miles between fares, which are also deductible. Thus it is important that you maintain a daily log of the miles driven from the beginning of your driving shift to the end of the shift. The total of the shift miles driven will be your business miles for the year. If you know the business miles driven and total miles driven, you can determine the percentage of vehicle use for business, which is used to determine what portion of the vehicle expenses are deductible.

You may use the actual expense method or an optional mileage method to determine your deduction for the use of the vehicle. If you choose the actual expense method in the first year you use the vehicle for business, you cannot switch to the optional mileage method in a later year. On the other hand, if you choose the optional mileage rate in the first year, you are allowed to switch between methods in future years, but your write-off for vehicle depreciation is limited to the straight line method rather than an accelerated method. For 2017, the optional mileage rate is 53.5 cents per mile. The IRS generally only adjusts the rate annually. If using the optional mileage rate, you need not track the actual vehicle expenses (but you still need to track the mileage).

The actual expense method includes deducting the business cost of gas, oil, lubrication, maintenance and repairs, vehicle registration fees, insurance, interest on the loan used to purchase the vehicle, state and local property taxes, and depreciation (or lease payments if the vehicle is leased). The business cost is the total of all these items multiplied by the business use percentage. Since the vehicle is being used to transport persons for hire, it is not subject to rules that generally limit depreciation of business autos, allowing for substantial vehicle write-off in the first year where appropriate. However, if you converted a vehicle that was previously used only personally, the depreciation will be based upon the lower of cost or current fair market value, and no bonus depreciation will allowed unless the conversion year was the same year as the purchase year.

Other deductions would include cell phone service, liability insurance and perks for your fares, such as bottled water and snacks. Depending on your circumstances, you may qualify for a business use of the home (home office) deduction. However, to qualify, the home office must be used exclusively in a taxpayer’s trade or business on a regular, continuing basis. A taxpayer must be able to provide sufficient evidence to show that the use is regular. Exclusive use means there can be no personal use (other than de minimis) at any time during the tax year. The office must also be the driver’s principal place of business.

Uber provides its drivers with detailed accounting information, and the only significant additional record keeping required is the miles traveled between fares, which is accomplished while in the vehicle. So justifying a home office is problematic. Even a portion of the garage where the vehicle is parked could qualify, but the use must be exclusive, which means the vehicle must be used 100% for business.

As a self-employed individual, you also have the ability to contribute to a deductible self-employed retirement plan or an IRA. Also, being self-employed gives you the option to deduct your health insurance without itemizing your deductions. However, these tax benefits may be limited or not allowed if you are also employed and participate in your employer’s retirement plan or if your employer pays for 50% or more of your health insurance coverage.

If you have additional questions about reporting your income and expenses, or the vehicle deduction options, please give us a call.

Five Steps You Need to Take After Jumping Into Entrepreneurship

Congratulations! You’ve decided to dive into the exciting world of entrepreneurship and bring that great business idea to life. Whether you’re opening a local brick-and-mortar business that your community needs, looking to grow rapidly in the next few years and get an investor, or just keep things small and solo, certain steps come next that aren’t as exciting as preparing for launch, but need to be done.

Here are the five important steps to take after you’ve decided it’s time to go from idea to delivery.

1. Choose the Right Business Entity.
How you organize your business plays a major role in taxes, bookkeeping, current and potential ownership, and overall administrative burden. While all of these considerations would need to be made regardless of the current state of the tax code, it’s especially important to think about in the face of massive tax overhaul. The GOP tax reform bill has become law and many changes go into effect starting January 1, 2018.

Some owners of pass-through businesses can expect to get a bonus deduction of up to 20 percent of profits up to $157,500 for most filing statuses and $319,000 for married filing jointly. Ninety-five percent of U.S. businesses are pass-through entities, which is a sole proprietorship, partnership, S corporation, or limited liability company (LLC) using the same tax structure as one of these entities, with the maximum income tax being 29.6 percent for pass-through income. For C corporations, the maximum corporate income tax rate is dropping from 35 percent to 21 percent.

Taxes aside, each state also treats business entities differently and may present bonuses and disadvantages you weren’t aware of. For example, many small business owners reap numerous benefits from S corporations but if you’re a New York City resident, you still have to pay city income tax. New York State recognizes S status but New York City doesn’t. Sales tax nexus, risk management, and legal aspects are other considerations to make when choosing an entity.

Depending on your entrepreneurial goals as well as personal needs, you need to decide which entity makes the most sense for your operations. If you plan to change entities in the near future due to taking on a partner or investor, you should also factor in how the tax bill will affect you.

2. Register your business with the appropriate state, local, and federal agencies.
When you organize your business, you may automatically be registered into your state or local agency’s database after filing articles of incorporation or similar documents. Check with your local Division of Corporations or other authority to make sure that you’ve taken all necessary steps to register your business once you’ve decided which entity to go with.

If you’re forming an LLC, you may need to file additional paperwork such as a publication affidavit which is when the state requires you to announce your commencement in a newspaper. This can be inexpensive or present a major cost barrier. For any “DBA” claims where you’re not doing business under your actual name or business entity name, you also need to check with your county clerk regarding forms and filing fees.

For federal agencies, most of the registration has to do with hiring employees, but even if you don’t plan on hiring any in the near future or ever, you still need to get an Employer Identification Number from the IRS. If you need to obtain licenses or approvals before operations commence, you also need to prioritize contacting these agencies and getting your paperwork taken care of before working with your first client.

3. Find business advisers, mentors, and peers.
You want to work with business advisers who can teach you about not just business in general, but also about the specific type of business that you’re operating and your industry. A good business adviser is one that will tell you both what you’re excelling at and what really needs improvement and how to achieve your business goals.

You want to find an adviser who’s on the same wavelength as you, but who can also give you the benefit of their knowledge and experience for your particular industry. In seeking out mentors and professional peers, you’ll want to find spaces for your profession or business type online and in person to exchange ideas and learn from each other. They’re excellent ways to grow your business while learning the ropes and you’ll learn the dos and don’ts of pre-launch.

4. Pick the right accounting software.
Even if you plan on outsourcing your accounting and tax responsibilities to a competent professional, you still need to have an accounting solution in place for them to work with. Jotting your expenses down on an Excel sheet can be a placeholder when you don’t have that many transactions yet and haven’t formally set up an entity in the very beginning, but it’s not going to be a viable long-term solution.

Accounting software isn’t as cost-prohibitive as it once was and there are many different products on the market meant for small business owners, solopreneurs, people who travel frequently, and even programs and apps that work in the cloud designed specially for certain industries and types of businesses. Cloud accounting programs are perfect for busy people who use multiple devices, so your accounting professional can see transactions in real time and correctly adjust them as you go.

If your business has more robust accounting needs such as inventory tracking and payroll, you need to test out the program and see if it works well for you. For most people without accounting knowledge, figuring out how to get accounting software set up can be daunting, so you also want to see if your tax professional can help you with this or if there are training videos and courses for your software.

5. Get ready to launch!
Once you’ve taken care of these crucial items pre-launch, it’s time to get going! You can now focus your time and energy on building a great product, finding the best staff, and cultivating a following for your brand. It’s just part of the game when you own a business.

While your business entity and accounting needs might not be as exciting as putting together your website and initial marketing blasts, it’s extremely important to have them sorted out beforehand so you aren’t scrambling to get tax paperwork in order right when things are really taking off for you. By establishing your entity, business registration, publication affidavits, and other business-related paperwork beforehand with the help of a business adviser, you’ll also have peace of mind that these things were done right the first time and you won’t need to stop what you’re doing to keep mailing in forms.

The journey to a successful business is definitely not an easy one. But if you’ve got a pre-launch roadmap and the right professionals on your side, you’ll minimize your chances of dealing with irksome bureaucratic obstacles so you can focus on growing your business. If you have any questions about jumping into entrepreneurship, and the important steps to take afterward, please contact us.

Hobby or Business? It Makes a Difference for Taxes

Taxpayers are often confused by the differences in tax treatment between businesses that are entered into for profit and those that are not, commonly referred to as hobbies. The differences are:

Businesses Entered Into for Profit – For businesses entered into for profit, the profits are taxable, and losses are generally deductible against other income. The income and expenses are commonly reported on a Schedule C, and the profit or loss—after subtracting expenses from the business income—is carried over to the taxpayer’s 1040. (An exception to deducting the business loss may apply if the activity is considered a “passive” activity, but most Schedule C proprietors actively participate in their business, so the details of the passive loss rules aren’t included in this article.)

Hobbies – Hobbies, on the other hand, are not entered into for profit, and the government does not permit a taxpayer to deduct their hobby expenses, in excess of any hobby income, on their tax return. Thus, hobby income is reported directly on their 1040, and any expenses not exceeding the income are deductible as miscellaneous itemized deductions on their Schedule A, assuming the taxpayer is not claiming the standard deduction, in which case they would be reporting income but not deducting the expenses.

So, what distinguishes a business from a hobby? The IRS provides nine factors to consider when making the judgment. No single factor is decisive, but all must be considered together in determining whether an activity is for profit. The nine factors are:

  1. Is the activity carried out in a businesslike manner? Maintenance of complete and accurate records for the activity is a definite plus for a taxpayer, as is a business plan that formally lays out the taxpayer’s goals and describes how the taxpayer realistically expects to meet those expectations.
  2. How much time and effort does the taxpayer spend on the activity? The IRS looks favorably at substantial amounts of time spent on the activity, especially if the activity has no great recreational aspects. Full-time work in another activity is not always a detriment if a taxpayer can show that the activity is regular; time spent by a qualified person hired by the taxpayer can also count in the taxpayer’s favor.
  3. Does the taxpayer depend on the activity as a source of income? This test is easiest to meet when a taxpayer has little income or capital from other sources (i.e., the taxpayer could not afford to have this operation fail).
  4. Are losses from the activity the result of sources beyond the taxpayer’s control? Losses from unforeseen circumstances like drought, disease, and fire are legitimate reasons for not making a profit. The extent of the losses during the start-up phase of a business also needs to be looked at in the context of the kind of activity involved.
  5. Has the taxpayer changed business methods in an attempt to improve profitability? The taxpayer’s efforts to turn the activity into a profit-making venture should be documented.
  6.  What is the taxpayer’s expertise in the field? Extensive study of this field’s accepted business, economic, and scientific practices by the taxpayer before entering into the activity is a good sign that profit intent exists.
  7. What success has the taxpayer had in similar operations? Documentation on how the taxpayer turned a similar operation into a profit-making venture in the past is helpful.
  8. What is the possibility of profit? Even though losses might be shown for several years, the taxpayer should try to show that there is realistic hope of a good profit.
  9. Will there be a possibility of profit from asset appreciation? Although profit may not be derived from an activity’s current operations, asset appreciation could mean that the activity will realize a large profit when the assets are disposed of in the future. However, the appreciation argument may mean nothing without the taxpayer’s positive action to make the activity profitable in the present.
There is a presumption that a taxpayer has a profit motive if an activity shows a profit for any three or more years within a period of five consecutive years. However, the period is two out of seven consecutive years if the activity involves breeding, training, showing, or racing horses.

All of this may seem pretty complicated, so please call this office if you have any questions or need additional details for your particular circumstances.