Many times, a friend or neighbor has told business owners, “You can deduct this or that from your taxes if you own a business…” Cathie hears that a lot. She says there are many myths and misunderstandings about the tax law, so one should ask questions of a professional who fully understands how the laws work.
There are two common myths or urban legends circulating among taxpayers who own S corporations, with only themselves as employees. One is that they are not employees. Secondly, because of this misunderstanding, some think they do not have to pay payroll. However, all shareholders who provide services to their corporations wear two hats. One hat is the owner hat and the other is the employee hat. All employees who receive funds from a corporation receive them as payroll. Shareholders are not exempt; they are employees of their corporation, and they must pay tax on that payroll.
Having settled that, the next question is how much should payroll be? The Internal Revenue Service has begun an audit initiative with S Corporations. They are making sure that S Corporations are paying “reasonable compensation.” The term “reasonable compensation” is generally the amount of money an employer would have to pay to an unrelated third party to perform the same tasks. Two ways to determine that amount are to inquire of other firms in the marketplace, and to check with industry groups who compile salary statistics.
A related misperception is that Limited Liability Company (LLC) owners do not pay payroll or self-employment taxes. An LLC is generally taxed as a partnership for income tax and payroll tax purposes. So, an owner/employee pays self-employment tax on her “payroll” (otherwise known as guaranteed payments). The IRS, in its desire to guide taxpayers, issued a Proposed Regulation that said all payments made to LLC owners were subject to self-employment tax. The CPA community protested, and although the Proposed Regulations were not withdrawn, the implementation date was delayed for further study. So, we do not have any specific regulation to rely upon; we can look to the “reasonable compensation” issue for S corporations as a guide.
Besides reducing taxes and finding out the truth about legal tax deductions, Cathie encourages business owners to plan with a financial adviser. “If I know about a pending transaction, I can help my clients structure it to take advantage of the existing tax laws,” she says. However, if a business owner waits until the transaction is complete, he or she may miss a tax benefit.
In addition, Cathie offers five tips to make tax time easier for all business owners.
- Prepare ahead of time: Develop a budget and plan ahead. Use bookkeeping software so the data is at your fingertips, allowing you to actively manage your business.
- Contribute to a retirement plan: The contributions are a tax deduction. What else allows you a tax deduction without spending the money? The government is paying you to save.
- Shift deductions to the year when you can best benefit: Use different tax brackets.
- Carefully choose the choice of entity: Even if you have been in business for many years, you may want to reassess this choice. The tax laws change, as does the business itself. Consult a tax adviser and review your current operations and future plans.
- Consider paying your family members when they provide services to the business: They may also then become eligible for retirement contributions.
During tax time Cathie sees about five clients a day. She needs about an hour with each client to review their data and answer any questions. Together, they consider planning issues for the upcoming year to make the most of new tax laws and changes in the client’s business. Don’t miss out. Get the tax deductions you deserve from your business by seeing a financial adviser during tax time.
Lisa Ragsdale lives in Albuquerque with her husband, Tim, and their four children. She teaches English at Central New Mexico Community College. |
