Archives for December 2020

President Signs COVID-19 Relief Act

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The President signed the COVID-19 Relief Act Sunday night. Echoing a previous post, a lot of uncertainty has been resolved. However, all may not be good in Mudville.

The deductibility of Paycheck Protection Program (PPP) loan expenses is generally seen as a positive result.  However, there is one catch.

If you are a shareholder in an S-Corporation or a member or partner in an LLC or partnership and you do not have basis (i.e., amounts at risk), the loss may not be deductible. Why? Because your PPP loan has not been forgiven in 2020, but will most likely be forgiven in 2021, which creates a mismatch of positive and negative basis adjustments.

The end result will be non-deductibility of your loss, which will be carried forward to 2021 when your loan is actually forgiven.  If you have enough basis, this will not be an issue for you and you can rest easy.

C-Corporations have no issue as it will create a Net Operating Loss (NOL) for future or carryback use.

Magone & Company clients who are concerned about deductibility should call us at (973) 301-2300 to discuss.

Entity Type Selection: Structuring for Long-Term Success

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A question we frequently hear from entrepreneurs and business owners is, “How should I structure my business for tax efficiency and business operations?” But one size does not fit all. The answer is dependent mostly on your goals for the company.

There are essentially four options to structure your business:

  • A traditional C-Corporation
  • An S-Corporation
  • A Partnership/LLC
  • A Sole Proprietor

Each entity has its own advantages and disadvantages regarding tax efficiency, types of owners and vulnerability of personal assets to creditors. Here’s a short rundown:

Sole Proprietorship
This is one of the simplest forms of business, but subjects you to the most risk. Owners have direct and sole control in the business making decisions. There is no separation of personal and business affairs. Raising capital may be difficult as banks typically depend on prior-year income to dictate the conditions of any loans, becoming stricter for businesses just getting started.

The tax return is filed with the business owner’s own personal return with a form Schedule C, mitigating the financial burden of filing a separate tax return for the business. Income is subject to the taxpayer’s ordinary income tax rates, with an additional 15.3% for self-employment tax (Social Security and Medicare) on the net business income. One-half of the self-employment tax is deducted to arrive at adjusted gross income on the personal income tax return.

Partnership/LLC
Partnerships can be as simple as a handshake between two entrepreneurs. A General Partnership gives all partners unlimited liabilities. A limited partnership requires at least one partner to manage the day-to-day activities, known as the General Partner, making them susceptible to unlimited liability. The remaining partners are passive investors with no part in management. Limited Partners still receive certain rights, such as voting about important issues.

An LLC requires more paperwork. You must file Articles of Incorporation and pay a fee with the state. LLCs must also file annual reports disclosing any changes in location, ownership or operations. LLCs are similar to a Limited Partnership as all partners receive limited liability.

If a member of an LLC dies or files bankruptcy, the LLC will dissolve. An advantage of a Limited Partnership is that a majority of remaining partners could vote to keep the business alive rather than terminate. Be aware that not all 50 states have a uniform treatment of an LLC. For example, some states limit the type of entities that may register as such, which can cause confusion for multi-state operations.

The form 1065 tax return is filed and partners receive form K-1 dictating their share of income or losses based on ownership percentages. Partners are provided guaranteed payments for services rendered or capital contributed rather than wages. Income is flowed through and taxed at the individual level at ordinary income tax rates.

For members active in day-to-day operations, the guaranteed payments and income from the partnership are subject to self-employment tax. General partners can use losses to offset other ordinary income. Any limited partner’s income will not be subject to self-employment tax, but is treated as passive. Passive losses may only offset passive income for tax purposes. Shareholders may take distributions in any manner partners agree.

S-Corporation
Incorporating as an S-Corporation becomes a bit more formal. Owners are required to file incorporation documents with their respective state, but not every state recognizes S-Corporation status. These states will tax the entity as a C-Corporation, meaning there will be double taxation. Shareholders are limited to 100 and they may only be U.S. citizens, U.S. residents and certain types of trusts.

S-Corporations are flow-through entities with income taxed at the individual level, but income retained by the corporation is not subject to the 15.3% self-employment tax like a sole proprietorship or partnership. Owners are required to take a “reasonable” salary based on the industry’s norm, with 2% shareholders being susceptible to taxability of various fringe benefits such as health insurance.

S-Corporations give shareholders limited liability, but also allows all shareholders to actively participate in the business. Owners are only liable for the capital they contributed into the corporation. It is important to separate personal and business assets so as to not “pierce the corporate veil” subjecting business debts to personal liability. Shareholders receive a form K-1 for their respective share of income and losses. Distributions, to the extent there are any, must be in proportion to ownership percentage to avoid termination of the S-corporation election.

C-Corporation
C-Corporations are similar to S-Corporations as the incorporation needs to be filed with their respective jurisdiction. Unlike other entities, owners’ personal assets are completely segregated from the assets of the corporation. Owners will typically take a salary as a form of payment. Form 1120 is filed and income is currently taxed at a flat 21% at the corporate level. Distributions are allocated to owners as taxable dividends. These dividends are taxed a second time at the individual level (double taxation). The tax rate depends on whether they are deemed ordinary or qualified; the maximum rate is 37% for ordinary and 20% for qualified.

With the incoming Biden administration, a new tax code change may be in the works. If implemented, the corporate tax rate of 21% will increase to a flat 28%. A minimum tax on corporations with book income over $100 million would also be incorporated. It would be structured similarly to an alternative minimum tax. This may make incorporating as an S-Corporation more favorable tax-wise depending on the threshold of income that would flow through to owners. The maximum individual tax rate would increase from 37% to 39.6%.

Weighing your options
A partnership must have at least two partners. A general partnership gives all partners unlimited liability, a limited partnership provides limited liability to all except at least one partner, and an LLC offers limited liability to all. Partnership entity type will be contingent on what capacity all partners are to be involved. Partnerships are more favorable for situations where you may not make consistent revenue, allowing you to take distributions as needed.

S-Corporations are more advantageous when revenue is more consistent. It gives owners the capability to take an annual salary, with distributions complementing any additional funds needed by the owners. A corporation provides the most division of personal and business assets as courts are able to “pierce the corporate veil” of S-Corporation, leaving shareholders susceptible to some type of limited liability.

Your choice of entity depends on your individual situation and plans moving forward. I would argue that most businesses begin as a sole proprietor — they have an idea and turn it into a profitable situation. Once they start buying assets and investing more into the business, it may be a good idea to incorporate as an S-Corporation. Soon enough, the company will be electing C-Corporation status and will be taken public with an Initial Public Offering.

All things being equal, it is important to have trusted advisors behind you at every stage of your business. At Magone & Company, our advisory services can help you select the best alternative based on your goals. We can also assist in implementing strategies to make the most tax-efficient choices.

PPP News: Stimulus Package Approved by Congress

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On December 20, 2020, Congress agreed on a $900 billion stimulus package. The President is expected to sign this legislation into law before Christmas.

What does this mean for you?
The uncertainty has finally been resolved! Businesses that received a Paycheck Protection Program (PPP) loan and had it forgiven would now be entitled to a tax deduction for costs covered by the loan. The COVID-19 relief bill clarifies that “no deduction shall be denied, no tax attribute shall be reduced, and no basis increase shall be denied, by reason of the exclusion from gross income provided” by Section 1106 of the CARES Act (which has been redesignated as Section 7A of the Small Business Act). This provision applies to loans under both the original PPP and subsequent PPP loans.

The COVID-19 relief bill creates a simplified forgiveness application process for loans of $150,000 or less.  Specifically, borrowers who received less than $150K would now be eligible to submit a simplified, one-page forgiveness application.

There will also be a new round of PPP loans available to businesses that are determined to be “eligible entities.” Businesses would need to demonstrate that the loan would be “necessary to support the on-going operations of the business.”

It appears that an “eligible entity” would be one with fewer than 300 employees that experienced at least a 25% reduction in revenue compared with the prior year or compared with the first quarter of 2020 for new businesses.

Stay tuned…

 

Business Operations, 2020 Edition: Connecting in a COVID World

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The year 2020 has brought much confusion and turmoil as a result of the COVID-19 global pandemic. As the world went into lockdown, many businesses were forced to close in an effort to decrease the spread of the virus. Unfortunately, many local businesses had to shut down due to financial issues, while others were faced with a new challenge of how to maintain operations in the new age of social distancing.

Large companies such as Google, American Express, Microsoft and Airbnb extended work from home policies indefinitely, with Google extending its policy into 2021. However, not all businesses have the luxury or resources to follow suit.

Fortunately, companies can take advantage of some opportunities despite the current global climate. Below, we will focus on the importance of technology and a change in mindset, which could help businesses continue to grow as if the pandemic never happened.

Technology: An investment, not an expense
Technology is extremely prevalent in the modern workplace. Every day we converse with clients via phone calls and email. Some companies, however, still value their face-to-face communication with clients. Did you know that there are more avenues of technology that can keep people connected?  COVID-19 has given birth to a different means of communication. Since the pandemic, there has been a drastic increase in demand for video calls via platforms such as Zoom, Microsoft Teams and Skype.

Utilizing video calls can help companies maintain relationships with clients as well as build new ones. This is more than a simple telephone call; the use of the video function allows for more meaningful communication because you can read the body language of the client.

At Magone & Company, we’ve made it a point to engage in video calls for almost all our client meetings and are seeing great results. Clients are more willing to help us in performing our procedures since we’ve made an extra effort to be present in their business, even from behind a screen.

Gone is the time of technology being an expense; it is an investment in the business and relationships that cannot be overlooked.

Turning pandemic challenges into business opportunities
Look for opportunities in your organization to change delivery processes or business development strategies using technology. It’s one thing to have the technology, but now you must use it. Some companies may not feel comfortable with the use of video conferencing due to a lack of knowledge, or maybe they just do not feel it will have a positive effect on business.

In contrast, a transition to a more remote based work setting can have significant positive outcomes, such as reduced rental expenses or building operating costs. Reimagine your facility needs as well as your hiring needs. What skill sets are required? Geography may no longer be an impediment to hiring the perfect candidate, though you still need to be cognizant of the state tax effect of such a decision.

For Magone & Company, we’re winning new work outside of our geographic region despite having no offices remotely close to the client location. Our consistent use of video calls allows our employees to build positive relationships and also produce efficient communication to discuss our engagement progress, without ever stepping foot in the office. What was unimaginable in January or February of 2020 is now standard operating procedure — and it’s paying significant dividends.

Embrace the transformation
The year 2020 has taught us that life can change instantaneously. One of the key components to a running a successful business is being open to change. COVID-19 brought more change than most would have hoped for, however this did not stop businesses from assessing new avenues of success.

Restaurants suffered greatly from the imposed lockdowns, which caused owners to develop solutions to help mitigate the risk of closing. As a response, many establishments experimented with outdoor dining and curbside pick-up as a means to generated revenue flow. Others have gotten even more creative. According to an article from the Journal of Accountancy, one particular restaurant owner considered transforming a section of his establishment into a market for customers to buy food.

The same can be accomplished with your business with the right mentality. At Magone & Company, we saw an opportunity to establish a more prominent advisory practice in which we help our clients be better prepared to operate. This proactive, rather than reactive, approach has helped our clients to establish more efficient and effective business strategies. How can you reimagine your business to take advantage of possible opportunities?

Yes, this year has been rough and challenging; however, as outlined above, there is no need to panic. There are ways that businesses can restructure, recalibrate and execute successful business tactics. We have seen positive outcomes to continue to help our clients grow.