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- Herausgeber: John Wiley & Sons
- Kategorie: Fachliteratur
- Serie: J.K. Lasser
- Sprache: Englisch
Maximize your bottom line with the nation's most trusted small business tax guide J.K. Lasser's Small Business Taxes 2018 is the small business owner's ultimate guide to a money-saving, stress-free tax season. Providing straightforward advice from the nation's most trusted tax expert on small business taxes, this book gives you the answers you need quickly, with clear, concise guidance. Updated and expanded to cover new and changing tax law, this edition also includes an e-supplement covering the latest developments from Congress and the IRS to keep you fully up-to-date. A complete listing of all available business deductions and credits helps you identify those you qualify for, and includes critical information on dollar limits, recordkeeping requirements, and how to actually take the write-off--all the way down to which line on which form. Organizational and planning strategies help you get through the process quickly and with fewer headaches, and this year's changes to the tax laws are explained in terms of how they affect your filing. Keeping up with the intricacies of tax law and filing is a full-time job--but it's not your full-time job. You have a business to run. This book gives you the guidance you need in the time that you have so you can get taxes out of the way and get back to work. * Learn which expenses qualify for deductions--and which ones don't * Adopt a more organized recordkeeping system to streamline the filing process * Explore small-business-specific strategies for starting or closing a business, running a sideline business, and operating in multiple businesses * Decode the various forms and worksheets correctly with step-by-step guidance * Review obligations for the 'other taxes,' including payroll and excise taxes Every year, millions of small business owners overpay their taxes because they lack the time and expertise to make tax-sensitive business decisions throughout the year only to learn that it's too late to act when it comes to tax time. Now you can put your money back where it belongs--in your business. J.K. Lasser's Small Business Taxes 2018 helps you take wise actions during the year and tells you how to file completely and accurately while maximizing your bottom line.
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J.K. LASSER’S™
SMALL BUSINESS TAXES 2018
Your Complete Guide to a Better Bottom Line
Barbara Weltman
Cover design: Wiley Copyright © 2018 by Barbara Weltman. All rights reserved.
Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.
Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.
For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www.wiley.com.
ISBN 978-1-119-38041-2 (paper)
ISBN 978-1-119-38040-5 (ePDF)
ISBN 978-1-119-38046-7 (ePub)
This book is dedicated with love to my understanding husband, Malcolm Katt.
Contents
Preface
Introduction
PART 1 Organization
1 Business Organization
Sole Proprietorships
Partnerships and Limited Liability Companies
S Corporations and Their Shareholder-Employees
C Corporations and Their Shareholder-Employees
Employees
Factors in Choosing Your Form of Business Organization
Forms of Business Organization Compared
Changing Your Form of Business
Tax Identification Number
2 Tax Year and Accounting Methods
Accounting Periods
Accounting Methods
Uniform Capitalization Rules
3 Recordkeeping for Business Income and Deductions
General Recordkeeping
Specific Substantiation Requirements for Certain Expenses
Records for Depreciation, Basis, Carryovers, and Prepaid Expenses
How Long You Should Maintain Records
PART 2 Business Income and Losses
4 Income or Loss from Business Operations
Business Income
Income for Service Businesses
Income from the Sale of Goods
Income from Farming
Income from Commercial Fishing
Investment-Type Income
Miscellaneous Business Income
State Income Taxes on Business Income
Net Operating Losses
Limitations on Business Losses
Income Earned Abroad
5 Capital Gains and Losses
What Are Capital Gains and Losses?
Tax Treatment of Capital Gains and Losses for Pass-Through Entities
Tax Treatment of Capital Gains for C Corporations
Loss Limitations
Sales of Business Interests
Special Situations
6 Gains and Losses from Sales of Business Property
Section 1231 Gains and Losses
Sale-Leasebacks
Installment Sales
Recapture
Involuntary Conversions
Abandonment, Foreclosure, and Repossession of Property
Sale of All the Assets of the Business
PART 3 Business Deductions and Credits
7 Employee Compensation: Salary, Wages, and Employee Benefits
Worker Classification
Temporary Workers and Outsourced HR
Deductible Employee Compensation
Compensation to Owners
Stock Options and Restricted Stock
Deferred Compensation
Disallowance Repayment Agreements
Employee Benefits
Golden Parachute Payments
Cafeteria Plans
Employment Tax Credits
8 Travel and Entertainment Expenses
Local Transportation Costs
Travel within the United States
Foreign Travel
Conventions
Living Away from Home on Temporary Assignments
Meal and Entertainment Expenses
Business Gifts
Reimbursement Arrangements
Recordkeeping Requirements
Employees
9 Car and Truck Expenses
Deducting Car and Truck Expenses in General
Actual Expense Method
Standard Mileage Allowance
Leasing a Car for Business
Arranging Vehicle Ownership
Employee Use of an Employer-Provided Car
Vehicle Trade-In
Trucks and Vans
Credit for Plug-In Electric Vehicles
Reimbursement Arrangements
Recordkeeping for Vehicle Expenses
10 Repairs, Maintenance, and Energy Improvements
Ordinary Repairs
Rehabilitation Plans
Small Business Safe Harbors
Rotable Spare Parts
Change in Accounting Method
Special Rules for Improvements for the Elderly and Handicapped
Lists of Deductible Repairs and Capital Improvements
Energy Improvements
11 Bad Debts
Bad Debts in General
Collection of Bad Debts
Business versus Nonbusiness Bad Debts
Loans by Shareholder-Employees
Guarantees That Result in Bad Debts
Special Rules for Accrual Taxpayers
Reporting Bad Debts on the Tax Return
Collection Strategies
12 Rents
Deducting Rent Payments in General
The Cost of Acquiring, Modifying, or Canceling a Lease
Improvements You Make to Leased Property
Rental of a Portion of Your Home for Business
Leasing a Car
Leveraged Leases
13 Taxes and Interest
Deductible Taxes
Nondeductible Taxes
Deductible Interest
Nondeductible Interest and Other Limitations on Deductibility
14 First-Year Expensing, Depreciation, Amortization, and Depletion
First-Year Expensing
Other Expensing Opportunities
General Rules for Depreciation
Modified Accelerated Cost Recovery System
Depreciation Methods
Bonus Depreciation
Limitations on Listed Property
De Minimis Safe Harbor Rule
Putting Personal Property to Business Use
Amortization
Depletion
15 Advertising Expenses
Ordinary Advertising Expenses
Promotion of Goodwill
Prizes, Contests, and Other Promotional Activities
Help-Wanted Ads
Websites and Apps
Social Media
16 Retirement Plans
Qualified Retirement Plans
Added Costs for Retirement Plans
Retirement Plans for Self-Employed Individuals
Regular 401(k)s and Designated Roth Accounts
Individual Retirement Accounts
MyRAs
State-Sponsored Plans for the Private Sector
When to Take Action
Actions to Avoid
Comparison of Qualified Retirement Plans
ESOPs
Correcting Plan Defects
Retirement Plans Owning Your Business
Nonqualified Retirement Plans
Glossary of Terms for Retirement Plans
17 Casualty and Theft Losses
Casualties and Thefts
Condemnations and Threats of Condemnation
Disaster Losses
Deducting Property Insurance and Other Casualty/Theft-Related Items
Certain Disaster Victims
Disaster Assistance
18 Home Office Deductions
Home Office Deductions in General
Special Requirements for Employees
Actual Expense or Simplified Method
Actual Expense Method
Simplified Method
Special Business Uses of a Home
Mobile Offices
Ancillary Benefits of Claiming Home Office Deductions
Impact of Home Office Deductions on Home Sales
19 Medical Coverage
Health Care Mandates
Deducting Medical Insurance for Employees
Deducting Health Coverage by Self-Employed Persons and More-Than-2% S Corporation Shareholders
Using Reimbursement Plans
Tax Credit for Contributions to Employee Health Coverage
Shifting the Cost of Coverage to Employees
Setting Up Health Savings Accounts (HSAs)
Archer Medical Savings Accounts (MSAs)
COBRA Coverage
Wellness Programs
Reporting Health Coverage on W-2s
Reporting Health Coverage on Forms 1095
20 Deductions and Tax Credits for Farmers
Farm Expenses
Timber Gains
Farm Losses
Farm-Related Tax Credits
Nondeductible Farm-Related Expenses
21 Domestic Production Activities Deduction
Background
Qualified Producers
Figuring the Deduction
22 Miscellaneous Business Deductions
Other Business Expenses in General
Job-Seeking Expenses
Moving Expenses
Educational Expenses
Charitable Contributions Made by Your Business
Licenses and Permits
Dues and Subscriptions
Legal and Professional Fees
Bank and Merchant Fees
Supplies, Materials, and Office Expenses
Uniforms and Clothing
Insurance
Commissions
Outsourced Workers
Payments to Directors and Independent Contractors
Penalties, Fines, and Damages
Meal Costs for Day-Care Providers
Expenses of Disabled Persons
The Dividends-Received Deduction
Foreign Housing Deduction
Other Expenses
23 Roundup of Tax Credits
Employment-Related Credits
Capital Construction–Related Credits
Other Tax Credits
General Business Credit
PART 4 Tax Planning for Your Small Business
24 Income and Deduction Strategies
Tax-Saving Tips
Audit-Proofing Your Return
Common Errors and How to Avoid Them
Tax Assistance
25 Tax Strategies for Opening or Closing a Business
Initial Tax Decisions to Make
Investing Your Own Resources
Debt versus Equity Financing
Tax Identification Numbers
Tax Reporting for the First Year
How to Write Off Start-Up Costs
Setting Up a Business Bank Account and Credit Card
Moving a Business
Aborted Business Ventures
Bankruptcy
Expenses of Winding Up a Small Business
Tax Reporting in the Final Year
26 Tax Strategies for a Sideline Business
Reporting Sideline Business Income
Hobby Losses
Business Expenses
27 Tax Strategies for Multiple Businesses
Advantages and Disadvantages of Multiple Entities
When to Run Multiple Activities within One Business
Treatment of Multiple Corporations
Tax Rules for Owners of Multiple Businesses
28 Alternative Minimum Tax
Alternative Minimum Tax Basics
Deduction Limits for Alternative Minimum Tax
Credit Offsets
Minimum Tax Credit
29 Other Taxes
State Income Taxes
Employment Taxes
Self-Employment Tax
Sales and Use Taxes
Excise Taxes
30 Filing Tax Returns and Paying Taxes
Income Tax Deadlines and Extensions
Online Filing of Business Income Tax Returns
Estimated Taxes
Making Tax Payments
Filing Other Business Returns
Using Tax Professionals
31 Retirement and Succession Planning
Retirement Planning
Exit Strategies
Financing Options to Fund Buyouts
Consulting Agreements
Estate Taxes
Estate Planning Concerns
32 Working with CPAs and Other Tax Professionals
Types of Tax Professionals
Finding a Tax Professional
Tips for Selecting a Tax Professional
33 Handling Audits with the IRS
Types of Audits
Appeals
Litigation
Mediation
Taxpayer Bill of Rights
Taxpayer Advocate Service
APPENDIX A Information Returns
Dividends
Large Cash Transactions
Payments to Independent Contractors
Pension and Retirement Plan Distributions
Retirement and Employee Benefit Plans
Small Cash Transactions
Wages
Health Coverage
Merchant Transactions
Foreign Accounts
APPENDIX B Tax Penalties
Failure to File a Tax Return or Pay Tax
Failure to File Correct Information Returns
Failure to File Correct Payee Statements
Accuracy-Related Penalties
Preparer Penalties
Penalty Relief
APPENDIX C Checklist of Tax-Related Corporate Resolutions
APPENDIX D List of Dollar Limits and Amounts Adjusted for Inflation
Items Adjusted Annually for Inflation
Items Fixed by the Tax Code
Items Set by the IRS
Index
EULA
List of Tables
Introduction
Table I.1
Chapter 1
Table 1.1
Table 1.2
Table 1.3
Table 1.4
Chapter 7
Table 7.1
Table 7.2
Chapter 8
Table 8.1
Table 8.2
Chapter 9
Table 9.1
Table 9.2
Table 9.3
Table 9.4
Table 9.5
Table 9.6
Table 9.7
Table 9.8
Table 9.9
Table 9.10
Table 9.11
Table 9.12
Chapter 10
Table 10.1
Table 10.2
Chapter 14
Table 14.1
Table 14.2
Table 14.3
Table 14.4
Table 14.5
Table 14.6
Table 14.7
Table 14.8
Table 14.9
Table 14.10
Chapter 16
Table 16.1
Table 16.2
Chapter 20
Table 20.1
Table 20.2
Chapter 22
Table 22.1
Table 22.2
Table 22.3
Chapter 23
Table 23.1
Chapter 24
Table 24.1
Table 24.2
Chapter 25
Table 25.1
Table 25.2
Chapter 27
Table 27.1
Chapter 29
Table 29.1
Table 29.2
Table 29.3
Chapter 30
Table 30.1
Table 30.2
Table 30.3
Chapter 31
Table 31.1
Appendix B
Table B.1
Table B.2
Table B.3
List of Illustrations
Chapter 1
Figure 1.1
Schedule C, Profit or Loss From Business
Figure 1.2
Schedule C-EZ, Net Profit From Business
Figure 1.3
Schedule K-1, Partner's Share of Income, Deductions, Credits, etc.
Figure 1.4
Form 8832, Entity Classification Election
Figure 1.5
Schedule E, Part II, Income or Loss From Partnerships and S Corporations
Figure 1.6
Form 1120, U.S. Corporation Income Tax Return
Chapter 14
Figure 14.1
Form 4562, Depreciation and Amortization
Chapter 16
Figure 16.1
Form 5305-SEP Simplified Employee Pension
Figure 16.2
Form 5304-SIMPLE Savings Incentive Match Plan for Employees of Small Employers
Figure 16.3
Form 5500-EZ Annual Return of One-Participant Retirement Plan
Chapter 18
Figure 18.1
Simplified Method Worksheet for Home Office Deduction
Figure 18.2
Worksheet to Figure the Deduction for Business Use of Your Home
Figure 18.3
Form 8829, Home Office Deduction
Chapter 21
Figure 21.1
Form 8903, Domestic Production Activities Deduction
Chapter 29
Figure 29.1
Schedule SE
Chapter 30
Figure 30.1
Estimated Tax Worksheet
Guide
Cover
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Preface
According to a 2017 report from the National Federation of Independent Business (NFIB), 84% of small businesses use paid tax preparers to file their returns. So why do you need to read up on taxes? The answer is simple: You, not your accountant or other financial adviser and not software, run the business, so you can't rely on someone else to make decisions critical to your activities. The National Small Business Association (NSBA) found that 67% of small businesses say that federal taxes have a significant or moderate impact on the day-to-day operation of their businesses. You need to be informed about tax-saving opportunities that continually arise so you can strategically plan to take advantage of them. Being knowledgeable about tax matters also saves you money; the more you know, the better able you are to ask your accountant key tax and financial questions that can advance your business, as well as to meet your tax responsibilities.
This is a great time to be a small business. Not only is small business a major force in our economy but it also is the benefactor of numerous tax rules that make it easier to write off expenses and minimize the taxes you owe. This edition of the book has been revised to include all of the new rules taking effect for 2017 returns. Your business needs to use every tax-saving opportunity to survive and thrive at this time. The book also provides information about future changes scheduled to take effect in order to give you an overall view of business tax planning. Most importantly, it addresses the many tax questions I have received from readers as well as visitors to my website, www.barbaraweltman.com.
This book focuses primarily on federal income taxes. Businesses may be required to pay and report many other taxes, including state income taxes, employment taxes, sales and use taxes, and excise taxes. Some information about these taxes is included in this book to alert you to your possible obligations so that you can then obtain further assistance if necessary. However, the book takes a holistic approach to taxes, showing you where applicable the ramifications that tax decisions can have on your business activities and your bottom line. Statistics, resources, and other materials are provided to help you better run your business by making good tax decisions and implementing sound business practices.
Whether or not you use a paid tax professional to prepare your tax return, expect to devote considerable time to taxes as part of running your business. The NFIB found that 42% of small businesses spend 4 hours or more each month on tax compliance, and 12% spend 10 hours or more each month. Also be prepared to spend money not only on your tax payments but also on administrative costs (e.g., accountants' fees). Nearly half of small businesses spend more than $5,000 annually, and 27% spend more than $10,000 each year, according to the same report. In another report, the Small Business Association found that 66% of owners polled thought taxes—the administrative hassles and cost—threatened their viability. And the NFIB found that 5 of the top 10 most severe problems facing small businesses are tax-related.
It is important to stay alert to future tax changes. Uncertainty has been labeled an impediment to business growth. Pending or possible changes from Congress are noted in this book, including the expiration of nearly a dozen tax rules at the end of 2016 that can impact your 2017 tax return and tax planning for 2018. Be sure to check on any final action before you take any steps that could be affected by these changes.
For a free supplement on tax developments after September 1, 2017, affecting small businesses (available in February 2018), go towww.jklasser.com or www.barbaraweltman.com.
How to Use This Book
The purpose of this book is to make you acutely aware of how your actions in business can affect your bottom line from a tax perspective. The way you organize your business, the accounting method you select, and the types of payments you make all have an impact on when you report income and the extent to which you can take deductions. This book is not designed to make you a tax expert. It is strongly suggested that you consult with a tax adviser before making certain important decisions that will affect your ability to minimize your taxes (and Chapter 32 tells you how to work with a tax professional). I hope that the insight you gain from this book will allow you to ask your adviser key questions to benefit your business.
In Part 1, you will find topics of interest to all businesses. First, there is an overview of the various forms of business organization and an explanation of how these forms of organization affect reporting of income and claiming tax deductions. The most common forms of business organization include independent contractors, sole proprietors, and sole practitioners—individuals who work for themselves and do not have any partners. If self-employed individuals join with others to form a business, they become partners in a partnership. Sometimes businesses incorporate. A business can be incorporated with only one owner or with many owners. A corporation can be a regular corporation (C corporation), or it can be a small business corporation (S corporation). The difference between the C and S corporations is the way in which income of the business is taxed to the owner (which is explained in detail in Part 1). There is another form of business organization called a limited liability company (LLC). Limited liability companies with 2 or more owners generally are taxed like partnerships even though their owners enjoy protection from personal liability. The important thing to note is that each form of business organization will affect what deductions can be claimed and where to claim them. Part 1 also explains tax years and accounting methods that businesses can select.
Part 1 contains another topic of general interest to all businesses. It covers important recordkeeping requirements and suggestions to help you audit-proof your return to the extent possible and protect your deductions and tax credits. In the course of business you may incur certain expenses, but unless you have specific proof of those expenses, you may not be able to claim a deduction or credit. Learn how to keep the necessary records to back up your write-offs in the event your return is questioned by the IRS.
Part 2 details how to report various types of income your business may receive. In addition to fees and sales receipts—the bread-and-butter of your business—you may receive other types of ordinary income such as interest income, royalties, and rents. You may have capital gain transactions as well as sales of business assets. But you may also have losses—from operations or the sale of assets. Special rules govern the tax treatment of these losses. The first part of each chapter discusses the types of income to report and special rules that affect them. Then scan the second part of each chapter, which explains where on the tax return to report the income or claim the loss.
Part 3 focuses on specific deductions and tax credits. It provides you with guidance on the various types of deductions you can use to reduce your business income. Each type of deduction is explained in detail. Related tax credits are also explained in each deduction chapter. In the first part of each chapter, you will learn what the deduction is all about and any dollar limits or other special requirements that may apply. As with the income chapters, the second part of each deduction chapter explains where on the tax return you can claim the write-off. The answer depends on your form of business organization. You simply look for your form of business organization to learn where on the return to claim the deduction. The portion of the appropriate tax form or schedule is highlighted in certain instances. As a practical matter, returns prepared on a computer automatically populate the appropriate form or schedule, but it's helpful to see where your write-offs end up on the return. For your convenience, key tax forms for claiming these deductions have been included. While the forms and schedules are designed for the 2017 returns, they serve as an example for future years. Also, in Chapter 22, Miscellaneous Business Deductions, you will find checklists that serve as handy reference guides on all business deductions. The checklists are organized according to your status: self-employed, employee, or small corporation. You will also find a checklist of deductions that have not been allowed.
Part 4 contains planning ideas for your business. You will learn about strategies for deferring income, boosting deductions, starting up or winding down a business, running a sideline business, running multiple businesses, and avoiding audits. It also highlights the most common mistakes that business owners make in their returns. This information will help you avoid making the same mistakes and losing out on tax-saving opportunities. You will also find helpful information about electronic filing of business tax forms and how to use the Internet for tax assistance and planning purposes. And you will find information about other taxes on your business, including state income taxes, employment taxes, sales and use taxes, and excise taxes. Finally, you will see how to work with a tax professional and what to do if you are audited.
In Appendix A, you will see a listing of information returns you may be required to file with the IRS or other government agencies in conjunction with your tax obligations. These returns enable the federal government to crosscheck tax reporting and other financial information. Appendix B covers tax penalties that can apply if you fail to do something you were supposed to do, or if you do it wrong or do it late. Appendix C contains a checklist of tax-related corporate resolutions to help you keep your corporate minutes book up to date. Appendix D is a list of dollar limits and amounts in certain tax rules that are adjusted annually for inflation to help you plan ahead.
Several forms and schedules as well as excerpts from them have been included throughout the book to illustrate reporting rules. These forms are not to be used to file your return. (In many cases, the appropriate forms were not available when this book was published, and older or draft versions of the forms were included.) You can obtain the forms you need from the IRS's website at www.irs.gov or where otherwise indicated.
Another way to stay abreast of tax and other small business developments that can affect your business throughout the year is by subscribing to Barbara Weltman's Big Ideas for Small Business®, a free online newsletter geared for small business owners and their professional advisers, and my “Idea of the Day®” (via e-mail) at www.barbaraweltman.com. The Supplement to this book, which covers developments after September 1, 2017, can be found at www.jklasser.com and my website www.barbaraweltman.com. For those who want to learn about tax responsibilities in starting up and running a business, check out my online courses listed on my website.
This book has been in print for nearly 25 years and has tracked dramatic changes in tax law and business operations. For those who are using it for the first time, the book is a resource guide for handling taxes effectively as well as for making financial decisions and using business practices to increase your bottom line. For those who are perennial readers, you will see that while much in the book is unchanged, it has been updated and expanded to reflect new tax rules and additional comments on tax strategies and business practices. For tax practitioners, I recognize that there are no citations, and that there are some issues that are unsettled. I invite your comments on any areas in which you disagree with my presentation and for ways to make improvements in future editions (send comments to [email protected]).
I would like to thank Sidney Kess, Esq. and CPA, for his valuable suggestions in the preparation of the original tax deduction book and Elliott Eiss, Esq., for his expertise and constant assistance with this and other projects.
Barbara Weltman September 2017
Introduction
Small businesses are vital to the U.S. economy. They employ nearly half of the country's private sector workforce and contribute more than half of the nation's gross national product. Small businesses created 64% of all new jobs over the past 15 years.
For the 2015 tax year (the most recent year for statistics), there were more than 24.7 million sole proprietorships in the United States. About one out of every 6 Form 1040 filers had a sole proprietorship that year. Another 7.8 million filers reported income from partnerships and S corporations. And the numbers of small businesses are growing.
Small businesses fall under the purview of the Internal Revenue Service's (IRS) Small Business and Self-Employed Division (SB/SE). This division services approximately 57 million tax filers, including 9 million small businesses (partnerships and corporations with assets of $10 million or less), more than 41 million of whom are full-time or partially self-employed, and about 7 million filers of employment, excise, and certain other returns. The SB/SE division accounts for about 40% of the total federal tax revenues collected. The goal of this IRS division is customer assistance to help small businesses comply with the tax laws.
Toward this end, the Small Business Administration (SBA) has teamed up with the IRS to provide small business owners with help on tax issues. The SBA provides tax information for start-ups at www.sba.gov; search “taxes.”
There is also an IRS Tax Center devoted exclusively to small business and self-employed persons at www.irs.gov/Businesses/Small-Businesses-&-Self-Employed. Here you will find special information for your industry—agriculture, automotive, child care, construction, entertainment, gaming, manufacturing, real estate, restaurants, retailers, veterinarians, and even tax professionals are already covered, and additional industries are set to follow. You can see the hot tax issues for your industry, find special audit guides that explain what the IRS looks for in your industry when examining returns, and links to other tax information.
As a small business owner, you work, try to grow your business, and hope to make a profit. What you can keep from that profit depends in part on the income tax you pay. The income tax applies to your net income rather than to your gross income or gross receipts. You are not taxed on all the income you bring in by way of sales, fees, commissions, or other payments. Instead, you are essentially taxed on what you keep after paying off the expenses of providing the services or making the sales that are the crux of your business. Deductions for these expenses operate to fix the amount of income that will be subject to tax. So deductions, in effect, help to determine the tax you pay and the profits you keep. And tax credits, the number of which has been expanded in recent years, can offset your tax to reduce the amount you ultimately pay.
Special Rules for Small Businesses
Sometimes it pays to be small. The tax laws contain a number of special rules exclusively for small businesses. But what is a small business? The average size of a small business in the United States is one with fewer than 20 employees with annual revenue under $2 million. The SBA usually defines small business by the number of employees—size standards range from 500 employees to 1,500 employees, depending on the industry or the SBA program. The SBA also uses revenue for certain business size standards (e.g., average annual gross receipts for many nonmanufacturing industries). Size matters because only “small businesses” can qualify for SBA-guaranteed loans and for special consideration with federal contracting.
For tax purposes, however, the answer varies from rule to rule, as explained throughout this book. Sometimes, it depends on your revenues, the number of employees, or total assets. In Table I.1 are more than 2 dozen definitions from the Internal Revenue Code on what constitutes a small business. You may be a small business for some tax rules but not for others.
Table I.1 Examples of Tax Definitions of Small Business
Reporting Income
While taxes are figured on your bottom line—your income less certain expenses—you still must report your income on your tax return. Generally, all of the income your business receives is taxable unless there is a specific tax rule that allows you to exclude the income permanently or defer it to a future time.
When you report income depends on your method of accounting. How and where you report income depends on the nature of the income and your type of business organization. Over the next several years, the possibility of declining tax rates (clarified in the Supplement) for owners of pass-through entities—sole proprietorships, partnerships, limited liability companies (LLCs), and S corporations—require greater sensitivity to the timing of business income.
The IRS reported a “tax gap” (the spread between revenues that should be collected and what actually is collected) of $450 billion a year and that $122 billion of this can be traced to entrepreneurs who underreport or don't report their income, or overstate their deductions. While audit rates have recently been at historic lows, the IRS continues to look carefully at self-employed individuals in an attempt to detect intentional or unintentional reporting errors.
Claiming Deductions
You pay tax only on your profits, not on what you take in (gross receipts). In order to arrive at your profits, you are allowed to subtract certain expenses from your income. These expenses are called “deductions.”
The law says what you can and cannot deduct (see below). Within this framework, the nature and amount of the deductions you have often vary with the size of your business, the industry you are in, where you are based in the country, and other factors. The most common deductions for businesses include car and truck expenses, utilities, supplies, legal and professional services, insurance, depreciation, taxes, meals and entertainment, advertising, repairs, travel, rent for business property and equipment, and in some cases, a home office.
Are your deductions typical? Back in January 2004, the Government Accountability Office (formerly the General Accounting Office) compiled statistics on deductions claimed by sole proprietors for 2001 (no data more current is available). These numbers showed the dollars spent on various types of deductions, the percentage of sole proprietors who claimed the deductions, and what percentage of total deductions each expense represented. For example, 25% of sole proprietors with business gross receipts under $25,000 claimed a deduction for advertising costs. This percentage rose to 65% when gross receipts exceeded $100,000. You can view these old statistics at www.gao.gov/new.items/d04304.pdf.
What Is the Legal Authority for Claiming Deductions?
Deductions are a legal way to reduce the amount of your business income subject to tax. But there is no constitutional right to tax deductions. Instead, deductions are a matter of legislative grace; if Congress chooses to allow a particular deduction, so be it. Therefore, deductions are carefully spelled out in the Internal Revenue Code (the Code).
The language of the Code in many instances is rather general. It may describe a category of deductions without getting into specifics. For example, the Code contains a general deduction for all ordinary and necessary business expenses, without explaining what constitutes these expenses. Over the years, the IRS and the courts have worked to flesh out what business expenses are ordinary and necessary. “Ordinary” means common or accepted in business and “necessary” means appropriate and helpful in developing and maintaining a business. The IRS and the courts often reach different conclusions about whether an item meets this definition and is deductible, leaving the taxpayer in a somewhat difficult position. If the taxpayer uses a more favorable court position to claim a deduction, the IRS may very well attack the deduction in the event that the return is examined. This puts the taxpayer in the position of having to incur legal expenses to bring the matter to court. However, if the taxpayer simply follows the IRS approach, a good opportunity to reduce business income by means of a deduction will have been missed. Throughout this book, whenever unresolved questions remain about a particular deduction, both sides have been explained. The choice is up to you and your tax adviser.
Sometimes, the Code is very specific about a deduction, such as an employer's right to deduct employment taxes. Still, even where the Code is specific and there is less need for clarification, disputes about applicability or terminology may still arise. Again, the IRS and the courts may differ on the proper conclusion. It will remain for you and your tax adviser to review the different authorities for the positions stated and to reach your own conclusions based on the strength of the different positions and the amount of tax savings at stake.
A word about authorities for the deductions discussed in this book: There are a number of sources for these write-offs in addition to the Internal Revenue Code. These sources include court decisions from the U.S. Tax Court, the U.S. district courts and courts of appeal, the U.S. Court of Federal Claims, and the U.S. Supreme Court. There are also regulations issued by the Treasury Department to explain sections of the Internal Revenue Code. The IRS issues a number of pronouncements, including Revenue Rulings, Revenue Procedures, Notices, Announcements, and News Releases. The IRS also issues private letter rulings, determination letters, field service advice, and technical advice memoranda. While these private types of pronouncements cannot be cited as authority by a taxpayer other than the one for whom the pronouncement was made, they are important nonetheless. They serve as an indication of IRS thinking on a particular topic, and it is often the case that private letter rulings on topics of general interest later get restated in revenue rulings.
What Is a Tax Deduction Worth to You?
The answer depends on your tax bracket. The tax bracket is dependent on the way you organize your business. If you are self-employed and in the top tax bracket of 39.6% in 2017, then each $100 deduction will save you $39.60. Had you not claimed this deduction, you would have had to pay $39.60 of tax on that $100 of income that was offset by the deduction. If you have a personal service corporation, a special type of corporation for most professionals, the corporation pays tax at a flat rate of 35%. This means that the corporation is in the 35% tax bracket. Thus, each $100 deduction claimed saves $35 of tax on the corporation's income. Deductions are even more valuable if your business is in a state that imposes income tax. The impact of state income tax and special rules for state income taxes are not discussed in this book. However, you should explore the tax rules in your state and ascertain their impact on your business income.
When Do You Claim Deductions?
Like the timing of income, the timing of deductions—when to claim them—is determined by your tax year and method of accounting. Your form of business organization affects your choice of tax year and your accounting method.
PART 1Organization
CHAPTER 1Business Organization
Sole Proprietorships
Partnerships and Limited Liability Companies
S Corporations and Their Shareholder-Employees
C Corporations and Their Shareholder-Employees
Employees
Factors in Choosing Your Form of Business Organization
Forms of Business Organization Compared
Changing Your Form of Business
Tax Identification Number
Alert
At the time this book was completed, Congress was considering important tax changes that could affect 2017 tax returns and planning for 2018. Check the online Supplement in February 2018 at www.jklasser.com or www.barbaraweltman.com to see what changes have been enacted and when they are effective.
If you have a great idea for a product or a business and are eager to get started, do not let your enthusiasm be the reason you get off on the wrong foot. Take awhile to consider how you will organize your business. The form of organization your business takes controls how income and deductions are reported to the government on a tax return. Sometimes you have a choice of the type of business organization; other times, circumstances limit your choice. If you have not yet set up your business and do have a choice, this discussion will influence your decision on business organization. If you have already set up your business, you may want to consider changing to another form of organization.
According to the Tax Foundation, 92% of all businesses in the United States are organized as sole proprietorships, partnerships, limited liability companies (LLCs), or S corporations, all of which are “pass-through” entities. This means that the owners, rather than the businesses, pay tax on business income. Nearly 50% of the private sector workforce is employed by these pass-through entities. The way in which you set up your business impacts the effective tax rate you pay on your profits (after factoring income taxes and employment taxes). Taxes, however, are only one factor in deciding what type of entity to use for your business.
As you organize your business, consider which type of entity to use after factoring in taxes (federal and state) and other consequences. Also consider whether to change from your current form of business entity to a new one and what it means from a tax perspective. Finally, be sure to obtain your business's federal tax identity number (or a new one when making certain entity changes).
For a further discussion on worker classification, see IRS Publication 15-A, Employer's Supplemental Tax Guide.
Sole Proprietorships
If you go into business for yourself and do not have any partners (with the exception of a spouse, as explained shortly), you are considered a sole proprietor, and your business is called a sole proprietorship. You may think that the term proprietor connotes a storekeeper. For purposes of tax treatment, however, proprietor means any unincorporated business owned entirely by one person. Thus, the category includes individuals in professional practice, such as doctors, lawyers, accountants, and architects. Those who are experts in an area, such as engineering, public relations, or computers, may set up their own consulting businesses and fall under the category of sole proprietor. The designation also applies to independent contractors. Other terms used for sole proprietors include freelancers, solopreneurs, and consultants. And it includes “dependent contractors”: self-employed individuals who provide all (or substantially all) of their services for one company (often someone laid off from a corporate job who is then engaged to provide non-employee services for the same corporation). Further, it includes those working in the “gig” economy for such companies as Uber, Lyft, HopSkipDrive, and TaskRabbit (although some workers for these companies are claiming to be employees and courts are reviewing their worker status).
Sole proprietorships are the most common form of business. The IRS reports that one in 6 Form 1040s contains a Schedule C or C-EZ (the forms used by sole proprietorships). Most sideline businesses are run as sole proprietorships, and many start-ups commence in this business form.
There are no formalities required to become a sole proprietor; you simply conduct business. You may have to register your business with your city, town, or county government by filing a simple form stating that you are doing business as the “Quality Dry Cleaners” or some other business name other than your own (a fictitious business name, or FBN). This is sometimes referred to as a DBA, which stands for “doing business as.”
From a legal standpoint, as a sole proprietor, you are personally liable for any debts your business incurs. For example, if you borrow money and default on a loan, the lender can look not only to your business equipment and other business property but also to your personal stocks, bonds, and other property. Some states may give your house homestead protection; state or federal law may protect your pensions and even Individual Retirement Accounts (IRAs). Your only protection for your personal assets is adequate insurance against accidents for your business and other liabilities and paying your debts in full.
Simplicity is the advantage to this form of business. This form of business is commonly used for sideline ventures, as evidenced by the fact that half of all sole proprietors earn salaries and wages along with their business income. For 2015 (the most recent year for statistics), more than 24.7 million taxpayers filed returns as sole proprietors.
Independent Contractors
One type of sole proprietor is the independent contractor. To illustrate, suppose you used to work for Corporation X. You have retired, but X gives you a consulting contract under which you provide occasional services to X. In your retirement, you decide to provide consulting services not only to X, but to other customers as well. You are now a consultant. You are an independent contractor to each of the companies for which you provide services. Similarly, you have a full-time job but earn extra money by performing chores for customers through TaskRabbit. Here too you are an independent contractor.
More precisely, an independent contractor or freelancer is an individual who provides services to others outside an employment context. The provision of services becomes a business, an independent calling. In terms of claiming business deductions, classification as an independent contractor is generally more favorable than classification as an employee. (See “Tax Treatment of Income and Deductions in General,” later in this chapter.) Therefore, many individuals whose employment status is not clear may wish to claim independent contractor status. Also, from the employer's perspective, hiring independent contractors is more favorable because the employer is not liable for employment taxes and need not provide employee benefits. (It costs about 30% more for an employee than an independent contractor after factoring in employment taxes, insurance, and benefits.) Federal employment taxes include Social Security and Medicare taxes under the Federal Insurance Contribution Act (FICA) as well as unemployment taxes under the Federal Unemployment Tax Act (FUTA).
You should be aware that the Internal Revenue Service (IRS) aggressively tries to reclassify workers as employees in order to collect employment taxes from employers. A discussion about worker classification can be found in Chapter 7.
There is a distinction that needs to be made between the classification of a worker for income tax purposes and the classification of a worker for employment tax purposes. By statute, certain employees are treated as independent contractors for employment taxes even though they continue to be treated as employees for income taxes. Other employees are treated as employees for employment taxes even though they are independent contractors for income taxes.
There are 2 categories of employees that are, by statute, treated as non-employees for purposes of federal employment taxes. These 2 categories are real estate salespersons and direct sellers of consumer goods. These employees are considered independent contractors (the ramifications of which are discussed later in this chapter). Such workers are deemed independent contractors if at least 90% of the employees’ compensation is determined by their output. In other words, they are independent contractors if they are paid by commission and not a fixed salary. They must also perform their services under a written contract that specifies they will not be treated as employees for federal employment tax purposes.
Statutory Employees
Some individuals who consider themselves to be in business for themselves—reporting their income and expenses as sole proprietors—may still be treated as employees for purposes of employment taxes. As such, Social Security and Medicare taxes are withheld from their compensation. These individuals include:
Corporate officers
Agent-drivers or commission-drivers engaged in the distribution of meat products, bakery products, produce, beverages other than milk, laundry, or dry-cleaning services
Full-time life insurance salespersons
Homeworkers who personally perform services according to specifications provided by the service recipient
Traveling or city salespersons engaged on a full-time basis in the solicitation of orders from wholesalers, retailers, contractors, or operators of hotels, restaurants, or other similar businesses
Full-time life insurance salespersons, homeworkers, and traveling or city salespersons are exempt from FICA if they have made a substantial investment in the facilities used in connection with the performance of services.
Day Traders
Traders in securities may be viewed as being engaged in a trade or business in securities if they seek profit from daily market movements in the prices of securities (rather than from dividends, interest, and long-term appreciation) and these activities are substantial, continuous, and regular. Calling yourself a day trader does not make it so; your activities must speak for themselves.
Being a trader means you report your trading expenses on Schedule C, such as subscriptions to publications and online services used in this securities business. Investment interest can be reported on Schedule C (it is not subject to the net investment income limitation that otherwise applies to individuals).
Being a trader means income is reported in a unique way—income from trading is not reported on Schedule C. Gains and losses are reported on Schedule D unless you make a mark-to-market election. If so, then income and losses are reported on Form 4797. The mark-to-market election is explained in Chapter 2.
Gains and losses from trading activities are not subject to self-employment tax (with or without the mark-to-market election).
Spousal Joint Ventures
Usually when 2 or more people co-own a business, they are in partnership. However, spouses who co-own a business and file jointly and conduct a joint venture can opt not to be treated as a partnership, which requires filing a partnership return (Form 1065) and reporting 2 Schedule K-1s (as explained later in this chapter). Instead, these “couplepreneurs” each report their share of income on Schedule C of Form 1040. To qualify for this election, each must materially participate in the business (neither can be a silent partner), and there can be no other co-owners. Making this election simplifies reporting while ensuring that each spouse receives credit for paying Social Security and Medicare taxes.
One-Member Limited Liability Companies
Every state allows a single owner to form a limited liability company (LLC) under state law. From a legal standpoint, an LLC gives the owner protection from personal liability (only business assets are at risk from the claims of creditors) as explained later in this chapter. But from a tax standpoint, a single-member LLC is treated as a “disregarded entity.” (The owner can elect to have the LLC taxed as a corporation, but this is not typical. An election may be made to be taxed as a corporation, followed by an S election, so that the owner can easily make tax payments through wage withholding rather than making estimated tax payments, as well as minimize Social Security and Medicare taxes.) If the owner is an individual (and not a corporation), all of the income and expenses of the LLC are reported on Schedule C of the owner's Form 1040. In other words, for federal income tax purposes, the LLC is treated just like a sole proprietorship.
Tax Treatment of Income and Deductions in General
Sole proprietors, including independent contractors and statutory employees, report their income and deductions on Schedule C, see Profit or Loss From Business (Figure 1.1). The net amount (profit or loss after offsetting income with deductions) is then reported as part of the income section on page 1 of your Form 1040. Such individuals may be able to use a simplified form for reporting business income and deductions: Schedule C-EZ, Net Profit From Business (see Figure 1.2). Individuals engaged in farming activities report business income and deductions on Schedule F, Profit or Loss from Farming, the net amount of which is then reported in the income section on page 1 of Form 1040. Individuals who are considered employees cannot use Schedule C to report their income and claim deductions. See page 28 for the tax treatment of income and deductions by employees.
Figure 1.1 Schedule C, Profit or Loss From Business
Figure 1.2 Schedule C-EZ, Net Profit From Business
Partnerships and Limited Liability Companies
If you go into business with others, then you cannot be a sole proprietor (with the exception of a spousal joint venture, explained earlier). You are automatically in a partnership if you join together with one or more people to share the profits of the business and take no formal action. Owners of a partnership are called partners.
There are 2 types of partnerships:
