How to Keep Family Loans Strictly Business

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Obtaining the funds to start or expand a small business doesn’t always come easy. If your family member can’t secure a loan from a commercial lender, you may be willing to help out by lending them the money yourself — but should you? Before handing over the cash, here are some best practices to consider:

Have a written agreement

Start by putting the loan agreement in writing. This may seem like an unnecessary formality, but without a written loan document, the IRS could argue that the transaction was a gift instead of a loan, potentially creating gift tax issues. Written documentation is also important if the borrower fails to repay all or part of the loan. In that situation, you want to be able to show you’re entitled to write off the unpaid amount as a non-business debt.

Charge adequate interest

The second step is setting an interest rate. While there’s no rule against interest-free loans or loans that have below-market interest rates, in a family context they can lead to tax complications. If you don’t charge sufficient interest, the difference between the amount of interest you actually receive (if any) and the amount you should have received — referred to as “imputed” interest — is taxable to you.

You can avoid the imputed interest rules by charging interest at the appropriate “applicable federal rate” (AFR). The IRS publishes AFRs monthly for loans of different maturities. These rates have been relatively low recently, reflecting the current market interest rate environment. For example, in November 2019, the annual AFR (using a monthly compounding assumption) was:

  • 1.68% for a short-term loan (three or fewer years)
  • 1.59% for a mid-term loan (more than three but no more than nine years)
  • 1.94% for a long-term loan (more than nine years)

For a term loan, the rate can remain fixed for the life of the loan. For a demand loan (one that gives you the right to demand full repayment at any time), you have to charge a floating AFR to avoid imputed interest issues.

What are the exceptions?

When you lend a family member no more than $100,000, the amount that can be added to your taxable interest income under the below-market interest rate rules generally can’t exceed the borrower’s net investment income. Even better, you won’t have to report any imputed interest if the borrower’s net investment income amounts to $1,000 or less. You can also side-step imputed interest on small loans of no more than $10,000, provided the borrowed funds aren’t used to buy or carry income-producing assets.

For more insight on family loans, and whether they’re a good idea for you, contact the NJ CPAs at Magone and Company at (973) 301-2300.

Employee vs. Independent Contractor — Why Worker Classification Matters

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Should a worker be treated as an employee or an independent contractor? There are legal differences between the two — and major tax distinctions as well.

 For an employee, a business must generally withhold income and FICA (Social Security and Medicare) taxes from the employee’s pay and remit those taxes to the government. In contrast, a business is not required to withhold income or FICA taxes for an independent contractor. The contractor is fully liable for his or her own self-employment taxes, and FICA and federal unemployment taxes do not apply. Generally, if a business has made payments of $600 or more to an independent contractor, it must file an information return (Form 1099-MISC) with the IRS and send a corresponding statement to the independent contractor.

Determining who’s who

Is a worker an independent contractor or an employee? The IRS examines factors in three categories:

  • Behavioral control — the extent to which the business controls how the work is done, whether through instructions, training or otherwise
  • Financial control — the extent to which the worker has the ability to control the economic aspects of the job. Factors considered include the worker’s investment and whether he or she may realize a profit or loss
  • Type of relationship — whether the worker’s services are essential to the business, the expected length of the relationship, and whether the business provides the worker with employee-type benefits, such as insurance, vacation pay, sick pay, etc.

When the proper classification is unclear, the business or the worker may obtain an official IRS determination by filing Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Consequences of misclassification

When an employer misclassifies an employee as an independent contractor, the IRS may impose penalties for failure to deduct and withhold income and/or FICA taxes. Penalties may be doubled if the employer also failed to file a Form 1099-MISC, though the lower penalty will apply if the failure was due to reasonable cause and not willful neglect.

Employers with misclassified workers may be able to correct their mistakes through the IRS’s Voluntary Classification Settlement Program (VCSP). For employers that meet the program’s eligibility requirements, the VCSP provides the following benefits:

  • Workers improperly classified as independent contractors are treated as employees going forward
  • The employer pays 10% of the most recent tax year’s employment tax liability for the identified workers, determined under reduced rates (but no interest or penalties)
  • The government agrees not to raise the issue of the workers’ classification for prior years in an employment tax audit

Your tax advisor can help you sort through the IRS rules and fulfill your tax reporting obligations. Have questions? Reach out to the tax experts at Magone & Company today at (973) 301-2300.

 

Does Business Structure Matter? You Bet it Does

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When you launch a new venture, there are endless decisions to make — from pricing your products and services to outsourcing or hiring in-house. But among the most important decisions is how you will legally structure your business. The structure you choose not only affects how your business is taxed, it can also be the key determinant in whether you’re held personally liable in a lawsuit. Here’s an overview of the various structures to consider:

Sole proprietorship

Sole proprietorship is a popular structure for single-owner businesses. In this structure, no separate business entity is formed, although your business may have a name (often referred to as a DBA, short for “doing business as”). A sole proprietorship does not limit liability, but insurance may be purchased for protection against risk.

In addition, business income and expenses are reported on a Schedule C — an attachment to your personal income tax return (Form 1040). Net earnings that the business generates are subject to both self-employment taxes and income taxes. As a sole proprietor, you may have employees, but you don’t cut a paycheck for yourself.

 Limited liability company

If you want protection for your personal assets in the event your business is sued, you might prefer a limited liability company (LLC). An LLC is a separate legal entity that can have one or more owners (called members). Income is usually taxed to the owners individually, and earnings are subject to self-employment taxes.

Corporation

A corporation is a separate legal entity that allows the company to transact business in its own name and file corporate income tax returns. Like an LLC, a corporation can have one or more owners, also known as shareholders. Shareholders are generally protected from personal liability, but can be held responsible for repaying any business debts they’ve personally guaranteed.

Partnership

In certain respects, a partnership is similar to an LLC or an S corporation. However, partnerships must have at least one general partner who is personally liable for the partnership’s debts and obligations. Profits and losses are divided among the partners and taxed to them individually.

No matter the structure you decide on, the laws that make that structure favorable are always subject to change. Be sure to reassess your business’s organizational structure regularly to ensure it provides the most benefits — Magone & Company can help. Call us today at (973) 301-2300 to reach our staff of professionals.

 

Maintaining Corporation Status: To Reap the Benefits, Follow the Rules

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Businesses often choose to structure as a corporation, because it offers owners the strongest protection from personal liability by treating it as a separate legal entity. But if you’re not operating your business like a corporation, you risk losing the liability security that you count on.

Getting back to the basics
No matter how long you’ve been in business, there are some elemental rules of thumb that corporations should follow to maintain their status:

  • Include the corporation’s name on all company letterhead, checks and invoices
  • Make checks out in the corporation’s name, not yours or another individual’s
  • Avoid mixing personal affairs with corporate business
  • Maintain separate bank accounts and credit cards, and keep careful records of corporate transactions
  • File tax returns and pay any corporate taxes on time

Document everything
In addition, shareholder and director meetings should be held on a regular schedule, with official minutes on the proceedings. Corporate minutes should provide documentation of key financial and legal decisions, such as:

  • Authorization for a substantial loan to or from the corporation
  • Adoption of a retirement plan or approval to make a contribution to an existing plan (for example, a profit-sharing contribution)
  • Issuance of stock
  • Purchase of property or approval of a long-term lease

By observing these formalities, you’ll have solid records on hand if the IRS, a creditor or a company insider challenges critical decisions.

Questions?
Contact Magone & Company today at (973) 301-2300 to learn how we can help you keep your corporate operations on the right track.

Time to Pay Up! Why it’s in Your Best Interests to File Your Taxes Early

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With the filing deadline moved to July 15th, you may have put off filing your taxes for as long as possible. Maybe you even requested an extension for October 15th. Most taxpayers dread the tedious task of compiling their financial documents and filing their taxes. Unfortunately, the longer you procrastinate, the greater the chances that something will go wrong. No matter the deadline, it’s always smarter to file your taxes sooner rather than later. Here’s why:

Help avoid tax identity theft. Tax return fraud is one of the most common and fastest growing forms of identity theft. In a nutshell, an identity thief steals your employment information and Social Security number, and files a fraudulent tax return on your behalf. They can steal your refund, or put you in the hole owing back taxes you might not actually owe. By filing your taxes as early as possible, a thief won’t have the chance to file a fraudulent return.

Find and correct mistakes sooner. Give yourself more time to fix any mistakes on your tax documents. For example, your employer might record the wrong earnings on your W-2. If you discover the mistake right before the filing deadline, you aren’t going to have enough time to get it resolved. Your tax return will end up getting delayed, which can result in having to request an extension and accrue penalties and interest.

Pay smaller penalty fees. Unfortunately, many taxpayers underestimate their tax liability during the year. That means they underpay and end up owing the government money. The IRS charges taxpayers a penalty for underpaying their taxes, as well as interest on the amount of taxes that they owe. So the sooner you file and pay any remaining taxes, the smaller your financial penalty and interest will be. If you can’t pay up front, you may have tax relief options to help you settle your debt.

Get it over with. There’s no better tax relief than just finally taking care of your taxes. If you are one of the many taxpayers that get stressed over taxes, you will actually feel better if you don’t procrastinate filing your tax return. Even if you owe back taxes, having a firm like ours represent you can be worth it in the long run.

Magone & Company specializes in tax resolution, and we’re experts in navigating the IRS maze. Reach out to our firm at (973) 301-2300 to schedule a no-obligation confidential consultation to explain your options to permanently resolve your tax challenges.

Taxation in a Time of Crisis: 4 Tips to Make Tax Time Less Taxing

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Whether it’s a global pandemic shutting the economy down for months, a stock market crash that terrifies investors or a housing industry slide that makes real estate a risky bet, living through tough economic times is never easy. But how you handle yourself and your money during a crisis can make all the difference. If you do it right, you could emerge stronger, wiser and richer on the other side.

If your income is uncertain, it can be hard to predict how much you might owe the IRS or how you can make those payments. And if you’re self-employed or a gig worker, this economic uncertainty can be even greater. So what can you do about your taxes when the economy takes a downturn? Here are some tips to make tax time less taxing when a crisis hits.

  1. Research filing extensions and be aware of new deadlines. During a period of economic turmoil, tax filing deadlines may be extended or relaxed. Do your homework and see how much time you really have. In the wake of the COVID-19 pandemic, the IRS extended the normal tax filing deadline to July 15, and many state and local governments followed suit. The same may happen in future crises, and it never hurts to find out for sure.
  2. File promptly if you’re expecting a refund. Getting extra time to file can be a welcome relief if you owe money to the IRS. But if the government owes you, it makes sense to file as quickly as possible. The processing of tax refunds is often disrupted during a crisis, due to short staffing and different procedures suddenly in place. The sooner you file, the sooner you will have your tax refund money.
  3. File promptly even if you’re NOT expecting a refund or might owe back taxes. The IRS is starting to enforce collections again, but they’re not oblivious to the financial crisis that many Americans are experiencing. The unemployment rate recently jumped to almost 15% — the highest unemployment rate since the Great Depression. And the outlook is uncertain. The IRS will likely consider settlements and more favorable terms to taxpayers in trouble, especially if their income drastically decreased due to COVID-19. So it’s important to file your taxes and be current in order to explore tax relief options.
  4. Use investments to cover the amount you owe. It’s easy to feel depressed when the stock market is reaching new lows every day. That’s why engaging in strategic tax loss harvesting could reduce your tax bill substantially when filing season rolls around. Tax loss harvesting is when you sell investments at a loss in order to reduce your tax liability. If you have investments that have not worked out as you’d hoped, selling them now and locking in the loss can be a great way to offset capital gains and lower your taxable income. As always, this is general guidance for informational purposes only. Be sure to consult your tax advisor for advice specific to your situation.

An economic crisis can make tax time even more difficult. That’s why it’s critical to have the right CPAs in your corner. Reach out to the experts at Magone & Co at (973) 846-8265, and we’ll schedule a no-obligation confidential consultation to explain your options.