Tuesday, September 30, 2014

Entity Owner Strategies that help minimize Social Security Taxes

Most business clients rightfully complain about the level of payroll (FICA or SE) taxes on their income.

In todays blog I will discuss few strategies and planning  which can reduce the burden off social security  taxes on small business owners .


Maximizing S Shareholder Distributions to Minimize Payroll Taxes

The taxable income passed through by an S corporation to shareholder-employees is not self-employment income for SE tax purposes This has lead to the tax planning strategy of minimizing the salary of S corporation shareholder-employees (and thus minimizing the payroll tax liability) and maximizing the amounts treated as S corporation dividend distributions. This still gets the cash in the hands of the shareholder-employee while minimizing the payroll tax burden. However, the taxpayer's age and qualification for maximum social security benefits should be considered before minimizing the current year payroll taxes. Also, the effect on the capacity to make deductible contributions to tax-favored retirement plan accounts should be considered (i.e., reduced salaries equates to reduced retirement plan contributions).


Example :     Minimizing salary income of S corporation shareholder-employees.

Amit is the sole shareholder of Shanti Inc., an S corporation. He works full-time in the business. During the current year, the corporation passes through ordinary income from operations of $85,000. The corporation pays an annual salary to Amit of $40,000. In addition, the corporation distributes $85,000 to Amit during the year as a distribution rather than paying this amount out as additional salary. Thus, wages and distribution payments to Amit for the year total $125,000.

If the $40,000 is a reasonable salary for the services performed by Amit, the transaction will probably withstand IRS scrutiny. In that case, the company and its shareholder have collectively saved the following amount of FICA tax by not paying the entire $125,000 as salary income to Amit :



OASDI Savings-[($117,000 wage base − $40,000 salary) × 12.4%]

$ 9,548

 

HI Savings-[($125,000 − $40,000) × 2.9%]

2,465

 

Total FICA tax savings

$ 12,013

 

 

  Caution: The IRS is well aware of this technique and, not surprisingly, frequently challenges such compensation arrangements as unreasonable. In several court cases, the IRS has successfully reclassified amounts originally treated as S corporation distributions to wage income-with the resulting additional FICA tax liability.
Example 4-8:     S shareholder distributions recharacterized as salary.

 Assume the same facts as in Example 4-7 except the IRS determines the $40,000 salary paid to Amit is unreasonably low. The IRS could recharacterize some or all of the $85,000 cash distributions as salary income subject to payroll taxes. Payroll tax penalties could also apply. The pass-through income from the S corporation would be amended to reflect the deemed wages and additional payroll taxes.

Thus, the planning technique works, but it must be used with judgment. In situations where any question exists, it is probably wise to document why amounts characterized as wages were not so low as to be unreasonable in relation to the services performed by the shareholder-employee. In addition, clients should be made aware that unreasonably low compensation of S corporation shareholder/employees is sometimes an audit issue with the IRS. Audit exposure is high especially when the shareholder/employee is a corporate officer,.

Following factors are considered in determining reasonable compensation (a) training and experience; (b) duties and responsibilities; (c) time and effort devoted to the business; (d) dividend history; (e) payments to nonshareholder employees, peers, and subordinates; (f) timing and manner of bonus payments to key employees; (g) the amount of compensation by comparable businesses for similar services performed; (h) compensation agreements; and (i) the use of compensation formulas by the corporation.

Employing Family Members
 Employing family members can be a useful strategy to reduce overall tax liability. If the family member is a bona fide employee, then the taxpayer can deduct the wages and benefits, including medical benefits, paid to the employee on Schedule C or F as a business expense, thus reducing the proprietor's SE tax liability (

 Employing the taxpayer's children can reduce overall tax liability. Children under age 18 who work for their parents are not subject to FICA or FUTA taxes. In addition, wage income would be taxed at the child's lower tax rate and may be wholly or partially offset by the child's standard deduction of up to $6,200 (for 2014). The wages must be reasonable for the work done. Additionally, a sole proprietor can provide up to $5,250 in annual tax-free educational assistance (for both undergraduate and graduate courses) to each eligible employee and deduct the costs (thus saving both income and SE taxes). Properly arranged, this benefit is available to the sole proprietor's child that is (a) age 21 or older, (b) a legitimate employee of the business, (c) not more than a direct 5% owner of the business, and (d) not a dependent of the parent business owner.


 Caution: Should the IRS choose to examine wages paid to family members, the taxpayer should be able prove the deduction. For payments to family members, it is especially important to ensure that basic business practices (e.g., keeping time reports, filing payroll returns, and basing pay on work performed, not on a relationship to the employer) are followed
 
 

Incorporating a Sole Proprietorship Can Save Payroll Taxes

 If a self-employed client is willing to live with the advantages and disadvantages of corporate taxation, using a C or S corporation can save payroll taxes. This is because essentially all of a sole proprietor's business income is subject to SE tax, while only the wage or salary income of a shareholder-employee is subject to FICA tax.
Incorporating a sole proprietorship can be especially beneficial when the business needs to retain income for expansion or debt retirement. Corporate income, unlike proprietor income, can be retained in the company free of either FICA or SE tax.
 
Leasing Property to a Closely Held Business
 A common tax planning strategy is for individuals to lease property to their closely held corporations or partnerships, especially in those states that do not impose sales or use tax on rental transactions. This can be an effective technique for withdrawing cash from a business entity without FICA or SE taxes, as would otherwise occur with salaries or guaranteed payments
 
These are some of the strategies that can be used to save social security taxes by effective tax planning .
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

Tuesday, September 16, 2014


Deducting Moving expeses

If you have moved from one job to another expenses related to move can be deducted from the tax return and can lead to substantial tax saving , this deduction is often over looked if the return is Self prepared . Below are the criteria to claim the deduction.

Expenses   incurred in moving   to a new principal residence are deductible if the move   is job related  These expenses   are deductible above the line in computing adjusted gross income. Moving   expenses   (for both foreign and domestic moves  ) are first reported on Form 3903 (Moving   Expenses  ). The total deductible expense   is then carried to line 26 of Form 1040 as an adjustment to gross income.

Advice: When a taxpayer's mailing address changes, a Form 8822 (Change of Address) should be filed with the IRS to change the taxpayer's address of record. This helps ensure that any future correspondence from the IRS is timely received and helps avoid any risk of not receiving IRS notices mailed to the taxpayer's last known address. A taxpayer's address of record generally is updated automatically when a return showing a new address is filed and processed by the IRS; however, the IRS maintains income tax records separate from gift, estate, and generation-skipping tax records. Thus, filing a Form 1040 showing a new address will not necessarily update the taxpayer's address of record for gift tax returns. Filing a properly completed Form 8822 ensures that the IRS has a taxpayer's new address for all federal tax matters.
 
Deductible Moving Expenses

The following expenses are deductible if the move is job related

1. The cost of transporting household goods and personal effects from the former residence to the new residence. This includes the cost to pack and crate, store, and insure household goods and personal effects within any period of 30 days in a row after they were moved   from the taxpayer's old home and before they were delivered to the new home.

 2. The cost of traveling from the former residence to the new residence. (Traveling expenses   include lodging but not meals.)

 Automobile expenses   can be calculated per mile in lieu of actual expenses  
Nondeductible Moving   Expenses 
Moving   expenses   other than those specifically allowed as deductions (see preceding discussion) are not deductible. Common nondeductible moving   expenses   include:

1. Meals while moving   from an old residence to a new residence.

2. Travel expenses  , meals, and lodging for a pre-move   house-hunting trip.

3. Meals and lodging while occupying temporary quarters in the area of the new job.

4. Expenses  of buying or selling a home or of entering or breaking a lease.

 Move Must Be Job-related

For moving   expenses   to be deductible, the move   must be job related. A move   is job related if the taxpayer meets two tests-(1) the time test and (2) the distance test .The time test requires the taxpayer to be employed full-time in the general location of the move for at least 39 weeks during the 12-month period following arrival at the new location. Employment need not be with same employer for all 39 weeks. A self-employed taxpayer must work full-time (at his own business or as an employee) for at least 39 weeks during the first 12 months and for at least 78 weeks during the 24-month period following the move. The distance test generally requires the new principal place of work to be at least 50 miles farther from a taxpayer's former home than his former principal place of work. (In other words, had the taxpayer not moved, commuting to the new work location would have increased his commute by 50 miles or more when compared to the commute to the prior workplace.)

For a taxpayer that goes to work full-time for the first time (e.g., college graduate), the taxpayer's place of work must be at least 50 miles from the taxpayer's former home to meet the distance test. This distance test also applies to a taxpayer returning to full-time work after a substantial period of part-time work or unemployment .

If a taxpayer claims a moving expense deduction with the expectation that the two tests will be satisfied and later fails to meet one or both tests, the amount deducted should be included in gross income for the first year that one or both of the tests are not satisfied . Alternatively, the taxpayer can amend his return for the year the moving expense was deducted .
A situation commonly encountered by two-earner families is for one spouse to be transferred, thus requiring the other spouse to find employment in the new location. The move   often is accomplished in two stages, with one spouse moving   immediately to take the new position and the other following later. However, moving   expenses   incurred more than a year after the start of a new job may not be deductible, depending on the particular facts and circumstances causing the delay

 Employer Reimbursements of Moving   Expenses 
Employer-paid moving   expenses   paid to the employee are reported on the employee's Form W-2. Employers handle employee moving   expenses   as follows: (1) deductible moving   expenses   paid by the employer to a third party or provided by the employer in-kind are not reported on Form W-2, (2) deductible moving   expense   reimbursements the employer pays directly to the employee are reported in box 12 of Form W-2 and identified with Code P, and (3) employer reimbursements for nondeductible moving   expenses   are included in the employee's taxable wages reported in box 1 of Form W-2.

When an employee is reimbursed for deductible moving   expenses   (i.e., shown with Code P in box 12 of Form W-2), the reimbursement is reported on Form 3903 along with all deductible moving   expenses   the employee incurred if the deductible moving   expenses   exceed the employer reimbursement. The excess expense   is then carried to and deducted on line 26 of Form 1040. If reimbursed moving   expenses   exceed actual deductible expenses   incurred, the excess is carried from Form W-2 to line 7 of Form 1040 and reported as additional taxable wages. The taxpayer need not file Form 3903if deductible moving   expenses   equal the amount of reimbursed moving   expenses   included in box 12 of Form W-2).

If an employee's entire reimbursement is included in box 1 of Form W-2,Form 3903should be filed with any allowable expenses   included. Reimbursements received are not included on the Form 3903when reported to the taxpayer as wages (i.e., box 1 of Form W-2).

Reimbursement Received and Expenses Paid in Different Tax Years

Generally, cash-basis taxpayers deduct moving expenses in the year paid, but often the reimbursement is received in the preceding or following year. If this occurs, the taxpayer can choose to deduct the expenses in the year of reimbursement if (1) the expenses were paid in a year before the year of reimbursement, or (2) the expenses were paid in the year immediately after the year of reimbursement but on or before the due date (including extensions) for filing the tax return for the year of the reimbursement . By reporting deductions in the year of reimbursement, taxpayers can avoid prepaying tax on the reimbursement income by matching revenues and expenses   in the year incurred.

A taxpayer who wants to deduct moving   expenses   in the year of reimbursement simply deducts them in that year. No special attachments or statements are required to document the election .

 
 

 

 


 

Sunday, September 7, 2014

Consultants: W-2, 1099 or Corp-to-Corp?

This seems to be a question in the mind of lot of Consultants who are trying to figure out : I have a new consulting gig, should I go W-2, 1099, Corp-to-Corp?

So What is the answer?
I have tried to summarize the answer in a simpler way


The biggest factor that should impact your decision is your own personality. The three options (W-2, 1099, and Corp-to-Corp) vary in complexity with W-2 being the simplest and setting up your own corporation the most complicated. You need to weigh the trade-offs of each approach and pick the one that fits your lifestyle best.

Based on your personality, here are the three options:

Consider W-2

If you're the kind of person that absolutely hates tax time, procrastinates until 10pm on April 15th, and would rather get a root canal than fill out a government form, you should consider W-2. You may not find the extra tax savings worth the headaches.

Below are the Pros and Cons for  Considering:

W-2 Pros:
  • Easiest and simplest option.
  • No bookkeeping needed other than submitting time sheets.
  • Some limited benefits may be available.

W-2 Cons:

  • Limited ability to defer income if a 401(k) benefit plan is unavailable.
  • Deductibility of unreimbursed business expenses and medical insurance premiums are very limited.
  • Getting health insurance coverage if none is provided can be a challenge.
  • Any benefit package is likely to be less generous than if you were a regular employee of the client
 

Are you detailed-oriented? Consider Corp-to-Corp

If you like to balance your check and credit card statements to the penny every month, you always get your tax returns in early or, ideally, have some accounting background, setting up and maintaining your corporation may not be that big a deal.

Corp-to-Corp Pros:

  • No self-employment tax.
  • Using small business retirement plans, you can defer tax on a larger percentage of income.
  • Double taxation of earnings is avoided as compared to regular corporations.

Corp-to-Corp Cons:

  • Most complicated option. Much more bookkeeping and tax reporting required.
  • Difficult to organize and dissolve.
  • Some states have a minimum tax you will have pay regardless of profitability.
  • You must receive at least some salary from the corporation, which means the corporation is subject to payroll taxes and filing.

Do you like to challenge authority? Choose 1099 at your own risk

If you are  not planning to go self employed for long term or taking an assignment on part time basis , you might consider the 1099  option. But there are some downsides to being self-employed that will probably lead you to choose one of the other two options: like your return is more likely to catch the eye of the IRS than any of the others discussed here.

1099 Pros:

  • Easy to get started.
  • Easy to discontinue when your contract ends.
  • Losses might be used to offset other income (limits apply).
  • Small business retirement plans offer the opportunity to defer more current income than traditional IRAs.
  • You might be eligible to take the Home Office Deduction.

1099 Cons:

  • Unlimited liability for the owner.
  • All profit is subject to self-employment tax in addition to the income tax.
  • More administration and bookkeeping than W-2 option.
  • You must make quarterly estimated tax payments