Tax Tips for Individuals

Choosing the right entity for your small business

by

If you’re thinking of starting a business, kudos to you! Starting a business can be an overwhelming experience in the beginning, but well worth it in the end.

Of all the decisions you’re going to make, one of the most important decisions that should not be taken lightly, will be the type of legal structure you will choose for your company, whether it may be a sole proprietorship, partnership, or corporate entity. This decision will definitely have an impact on your tax obligations, it will affect the amount of paperwork your business will be required to complete and process. It also has ramifications for your personal liability.

Before we get into the various business types, there are some considerations which lead to one business form over another regardless of tax advantages. For example, do you have foreign partners or investors, will you operate in various states, will you seek venture capital (if so, how soon)? These are but a handful of considerations that need to be considered. Let’s now look at the various business forms.

Types of business entities

Sole proprietorship is the most common form of business organization and easiest to operate. It is very simple to form often requiring only registering a Doing Business As (DBA) with the county courthouse. A mistake many owners make since this form of business is so easy to form and operate is they are lax in maintaining adequate books and records and frequently commingle business and personal expenses in the checkbook.

Tip – Open a separate checking account and pay yourself a draw. Pay business expenses from the business account and personal expenses from your personal checkbook.

Another consideration is this type of entity makes the owner personally liable for any and all financial obligations pertaining to the business. Think bankruptcy or liability from acts of your employees, such as an auto accident. I’m not referring to professional liability such as doctors, professionals are always held personally liable. Thought must be given to the nature of your business and potential for liability before selecting this form of entity.

Finally, adequate and accurate books and records are required, but the owner does not take a salary. The owner takes a draw and pays the federal, social security and state taxes assuming no employees via quarterly estimated tax payments. Keep in mind your draw is your “gross” pay check. This means you’ll need to estimate a reserve for income and social security taxes from each draw, no different than you would withhold taxes for an employee.

Tip –Establish a separate bank account for your tax liability and transfer the estimated amount for taxes to this account to establish a delineation between funds available for operations versus those earmarked for taxes.

A partnership consists of two or more people who agree to share in the profits and losses of a business. Similar to a sole proprietor, partners do not take salaries, but rather take guaranteed payments. The guaranteed payments are deducted from the net income, but included as partner’s compensation and subject to income and social security taxes.

Depending on whether a partner is a general partner or a limited partner, they may be held personally liable for the financial obligations of the business, absent personal guarantees. Many individuals form partnerships to avoid double taxation such as is the case with C-Corporations. Partnership tax law is one of the most complex areas of the tax code due to the flow-through nature of income, expenses, gains and losses. However, it’s useful when partners want flexibility in partner sharing percentages for income and losses.

Tip –Make sure you have a partnership agreement in place from the start. This can help you avoid heartache and expensive litigation if the partnership ever goes sour.

A corporation is a legal entity incorporated within a state. Many corporations are formed in Delaware, since most attorneys are trained in Delaware law and the law of their home state. The corporation is a separate entity, subject to federal and state taxation. Like a person, the corporation can be taxed and can be held legally liable for its actions.

Most venture capitalists require a corporate structure to facilitate investment and eventual sale, or public offering. In addition, there is the possibility certain officer fringe benefits and those of other shareholders will not be subject to tax as is the case with partnerships or S-corporations.

Tip –The key benefit of corporate status is the avoidance of personal liability, so long as the corporate veil is not pierced. Bes sure to work with a knowledgeable advisor to make sure you have the right documents and processes in place to take full advantage of corporate status.

The primary disadvantage is the cost to form a corporation and the extensive record-keeping (minutes, resolutions, etc). While double taxation is sometimes mentioned as a drawback to incorporation, the S corporation (or Subchapter S-corporation, a popular variation of the regular C-corporation) avoids this situation by allowing income or losses to be passed through on individual tax returns, similar to a partnership. Similar to the partnership tax laws, those applying to the Subchapter S-corporation are often quite complicated due to the flow-through nature of the income and expenses.

A hybrid form of partnership, the limited liability company (LLC), is very popular among new business owners and the legal community. LLCs offer personal liability protection for the owners, but for income tax purposes they are treated as a sole proprietorship if there is one owner or a partnership if more than one.

Tip –An LLC can elect to be treated as a corporation, but this is seldom done unless there are extenuating circumstances, for example foreign owners.

The foregoing is meant to provide a broad overview of the types of business entities a new business owner may choose. Each choice carries with it its own advantages and disadvantages based on your goals, so be sure to consult your CPA or other  trusted business advisor before making any decisions.

Need help talking through your options? Magone & Co. CPAs can help you make the decision that’s right for your needs and goals.

Tax Reform Update: Alimony

by

Under the current rules, an individual who pays alimony or separate maintenance may deduct an amount equal to the alimony or separate maintenance payments paid during the year as an “above-the-line” deduction. (An “above-the-line” deduction, i.e., a deduction that a taxpayer need not itemize deductions to claim, is generally more valuable for the taxpayer than an itemized deduction.) And, under current rules, alimony and separate maintenance payments are taxable to the recipient spouse (includible in that spouse’s gross income).

However, new rules are coming soon
Under the Tax Cuts and Jobs Act rules, there is no deduction for alimony for the payer. Furthermore, alimony is not gross income to the recipient. So for divorces and legal separations that are executed (i.e., that come into legal existence due to a court order) after 2018, the alimony-paying spouse won’t be able to deduct the payments, and the alimony-receiving spouse won’t include them in gross income or pay federal income tax on them.

These new rules don’t apply to existing divorces and separations
It’s important to emphasize that the current rules continue to apply to already-existing divorces and separations, as well as to divorces and separations that are executed before 2019.

Some taxpayers may want the Tax Cuts and Jobs Act rules to apply to their existing divorce or separation. Under a special provision, if taxpayers have an existing (pre-2019) divorce or separation decree, and they have that agreement legally modified after Dec. 31, 2018, the new rules apply to that modified decree if the modification expressly so provides.

There may be situations where applying these new rules voluntarily is beneficial for the taxpayers, such as a change in the income levels of the alimony payer or the alimony recipient.

To discuss the impact of these rules on your particular situation, please call us at (973) 301-2300.

How will federal tax law changes impact your NJ business?

by

The federal Tax Cuts and Jobs Act, which represents the first major U.S. tax code overhaul in 30 years, seems to provide small businesses everywhere with a break on their taxes. For NJ business owners and managers, it’s critical to understand how the new mandates will affect your organization.

Pass-through business deduction
Pass-through companies account for 95 percent of all U.S. businesses. These entities allocate corporate income among the owners, rather than paying income taxes at the corporate level. Effective this year, pass-through companies will receive a 20 percent tax deduction. This deduction lowers a business’s taxable income by 20 percent, providing small business owners with more financial breathing room and freeing up money for hiring new workers and expanding operations.

There is one limitation: Married individuals who own service-based businesses (e.g. law firms or doctor’s offices) can only claim the deduction if their annual income is below $315,000 ($157,500 if single).

First-year bonus depreciation
This depreciation deduction is increasing from 50 to 100 percent. This allows businesses to deduct the full amount of eligible equipment and property purchases, rather than writing off a portion. Lawmakers hope this change will encourage business owners to put more money back into their companies — increasing R&D, expanding staff or branching out into new geographic markets.

Net operating loss window
Previously, net operating losses (NOL) — when a business’s tax deductions are greater than its taxable income — could be carried back for two years. Now, they can be applied for an indefinite amount of time. Net operating losses occur when a business’s tax deductions are greater than its taxable income. While this can only be applied to 80 percent of taxable income, it can help businesses to take risks and spend more money, essentially lowering the cost of failure.

Elimination of transportation fringe benefits
Businesses must now do without the transportation fringe benefits and entertainment expense deduction — tax-free employee commuter plans and reduced-rate entertainment plans. These perks can still be provided by employers, but can’t be written off as business expenses.

Lower corporate tax rate
The corporate tax rate is decreasing from 35 to 21 percent. That means corporations may be more inclined to set up shop and stay put, and less likely to move overseas. The new tax rate gives companies an opportunity to make more money, and can give the U.S. a competitive edge on a global level.

Keep in mind, this is just a general summary of new tax laws and should not be considered financial or legal advice. Be sure to consult with your CPA or tax advisor for advice specific to your business.

Tax reform 2018: What you need to know now

by

Congress has ushered through the biggest tax reform law since 1986, when President Reagan signed major legislation for corporations and individuals. The new law will affect the way you, your family and your business calculate your federal income tax bill — and the amount of federal tax you will pay.

As we prepare for the changes in 2018, here are a few highlights of the new law to keep in mind:

  • Lower tax rates are coming. The Tax Cuts and Jobs Act will reduce tax rates for many taxpayers. Additionally, many businesses, including those operated as pass-through, such as partnerships, may see cuts in their tax bill.
  • Seven tax brackets for individuals will remain, but rates will change. Rates will be lowered to: 10%, 12%, 22%, 24%, 32%, 35% and 37%, respectively.
  • The child tax credit has nearly doubled. Parents will receive $2,000 for each child under 17, and the entire credit can be claimed by single parents who make up to $200,000 or married couples who make up to $400,000.
  • There’s a new tax credit for non-child dependents. Taxpayers may now claim a $500 temporary credit for non-child dependents, such as children over age 17, elderly parents or adult children with a disability.
  • Expect disappearing or reduced deductions, and a larger standard deduction. Beginning next year, the Tax Cuts and Jobs Act will also suspend or reduce many popular tax deductions in exchange for a larger standard deduction.
  • The itemized deduction for charitable contributions will remain. But because most other itemized deductions will be eliminated in exchange for a larger standard deduction, charitable contributions may not yield a significant tax benefit.
  • The new law temporarily boosts itemized deductions for medical expenses. For 2017 and 2018 these expenses can be claimed as itemized deductions to the extent they exceed a floor equal to 7.5% of your adjusted gross income (AGI). However, next year many individuals will have to claim the standard deduction because many itemized deductions have been eliminated.
  • The standard deduction has nearly doubled. For single filers, the standard deduction has increased from $6,350 to $12,000; for married couples filing jointly, it’s jumped from $12,700 to $24,000.

This is a general summary of the new law and should not be considered tax advice. Be sure to consult with your CPA or tax advisor for advice specific to your situation.

Tax reform opportunities to consider as 2017 winds down

by

Congress is enacting the biggest tax reform law in 30 years — one that will fundamentally change the way your federal income tax bill is calculated. Since most of the changes will go into effect next year, there’s still a narrow window before year-end to soften or avoid the impact and best position yourself for the tax breaks that may be heading your way.

Here are 7 last-minute moves to consider as 2017 comes to a close:

  1. If you’re about to convert a regular IRA to a Roth IRA, postpone the conversion until next year. That way, you’ll defer income from the conversion until next year and have it taxed at lower rates.
  2. If you’re not subject to the Alternative Minimum Tax (AMT), pay the last installment of your 2017 estimated state and local taxes no later than December 31, 2017, rather than on the 2018 due date.
  3. Charitable contributions after 2017 may not yield a tax benefit because you won’t be able to itemize deductions, so consider accelerating some charitable giving into 2017.
  4. Consider accelerating “discretionary” medical expenses into this year. For example, get new glasses or contacts, or see if you can squeeze in expensive dental work such as an implant.
  5. If a higher alternative minimum tax (AMT) exemption in 2018 means you won’t be subject to the 2018 AMT, it may be worthwhile to push such deductions into next year, such as exercising an incentive stock option (ISO).
  6. Under the new law, alimony payments aren’t deductible by the payor or includible in the income of the payee, generally effective for any divorce decree or separation agreement executed after 2017. So if you’re in the middle of a divorce or separation agreement and anticipate winding up on the paying end, it would be to your advantage to wrap things up before year end. On the other hand, if you’ll likely wind up on the receiving end, it would be worth your while to wrap things up next year.
  7. The new law suspends the deduction for moving expenses after 2017 (except for certain members of the Armed Forces), as well as the tax-free reimbursement of employment-related moving expenses. So if you’re in the middle of a job-related move, try to incur your deductible moving expenses before year-end. Or, if the move is connected with a new job and you’re getting reimbursed by your new employer, press for reimbursement before year-end.

These are just some of the general year-end moves that should be considered in light of the new tax law. As always, this should not be considered tax advice. Be sure to consult with your CPA or tax advisor for advice specific to your situation.