By James T. Stimler, Esq.
New business owners and investors must avoid common tax pitfalls to achieve success. An accurate and complete understanding of threshold tax record-keeping, filing deadlines and payment obligations are very important when choosing your business entity form and deftly operating that business. Selecting the proper business structure and taxation and ownership planning are crucial to correctly registering the business with different taxing authorities and effectively constructing legal agreements/documents between investors at the formation of the business. These decisions include but are not limited to: choice of business/legal entity, permissible types of shareholders, and the allocation of profits and losses. This is especially true for businesses formed as so-called “pass-through” entities such as a Limited Liability Company (LLC), Sub S Corporation or Partnership. In a pass-through entity, the entity does not pay income tax itself but rather passes the income tax obligations through to the business members, shareholders or partners. These business structural decisions, made in consultation with your attorney and CPA, will facilitate the proper preparation of company tax returns and other tax filings.
Business Operations Structure and Cash Flow Management
Be sure to know if the business entity/equity owners will be taxed on a cash basis or accrual basis. Accrual basis taxpayers compute income when they actually earn it or become entitled to it, but not necessarily when they receive it. Their deductions are computed based on when debts were incurred, but not necessarily paid. Cash basis taxpayers compute their income when they/the business actually receive the payments/income.
There are several types of taxation potentially related to the income received by a business for the sales of products and/or services, including: sales tax; entity income tax; member/partner/shareholder pass through income tax; and Commercial Activity Tax (CAT). There are several types of taxation related to having employees, including: federal, state and city employee income tax withholding; FICA/Medicare; Workers’ Compensation, and federal and state unemployment tax. Each tax will have its own record-keeping, reporting, filing and payment requirements that arise from the structure of business operations and the management of cash flows. Remember, even if an extension to file the tax report/return is available, an estimated tax payment is often still due by the initial deadline.
Consult municipal and state government taxation agency websites for more information regarding regulations pertaining to your specific business locale. Click here for more information on federal business tax parameters.
Equity Owner Taxation
A fundamental issue for equity owners of an LLC, S Corporation and/or Partnership is to be sure that the business entity makes timely and sufficient distributions to them, so that the equity owners can timely report and pay the income tax obligations flowing through to them from the business entity. Usually, these distributions to equity owners to pay income tax obligations are a primary obligation specifically stated in the business entity formation documents like a LLC Operating Agreement, Shareholder/Close Corporation Agreement, or Partnership Agreement. Also, a decrease in partnership liabilities may in certain circumstances be required to be reported as a taxable gain on a partner’s income tax return.
Deductibility Limitations of Considerable Business Equipment and Real Estate Expenses
The full amount of the purchase price paid for considerable business equipment or real property with buildings will not necessarily be deductible against income in the year of purchase. The deduction will be based upon the estimated useful life amount permitted to be deducted per year under IRS regulations, which are quite complex, and are subject to annual and other limitations. Considerable business equipment expenses may include machinery, furnishings or vehicles. For example, automobile and light duty truck expenses are deducted/amortized over 5 years, not all in the year of purchase. Nonresidential [commercial, retail or industrial] real property is deducted/depreciated over 39 years.
See IRS Publication 946, How to Depreciate Property, for more info.
Taxation of Employee Benefits Rules Impact on Equity Owners
The type and processing of employee benefits (e.g. health insurance premiums, group term life insurance, qualified dependent care assistance program) can determine if a shareholder-employee who owns more than 2% of an S Corporation will receive the benefit. Whether a shareholder-employee will be taxed on that benefit (perhaps including FICA tax), or get a personal deduction for the benefit, can also be affected by the type and processing of the employee benefit. Review and track in advance with your CPA and/or attorney each employee benefit you desire for yourself and your non-equity owning employees, to be sure that you understand the applicable rules to each benefit when you are choosing a form of business entity and designing the operations of the company.
Special Note: In considering availability and taxation of employee benefits for equity owners, be mindful to factor in the deemed ownership of equity-attribution rules regarding related parties. The attribution rules require the inclusion/compiling of equity interests owned by related parties such as spouses, children, siblings, and parents in the calculation of availability and taxation of employee benefits for each individual LLC member, corporate shareholder, etc.
SUMMARY: Savvy new business owners/investors can avoid tax pitfalls and achieve success by cultivating an understanding of the multifaceted framework of business/employer taxation to select the proper form of business entity, create investor agreements, structure business operations, and manage cash flows.
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This blog article is for general educational purposes only and may not be relied upon as legal advice from the author to the reader.
© 2018 James T. Stimler, Esq.