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MEDICAL PRACTICES

Compensation- or Dividend in Disguise?

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When your corporation has a profitable year, do you take more salary or pay yourself a year-end bonus? Since you are pivotal to your company’s success, paying yourself more in the good years only makes sense. Increasing or decreasing your compensation from year to year based on company performance can also help manage your company’s cash flow — and the amount of income taxes it has to pay.

Tax Impact

A corporation may deduct compensation as a business expense if it is reasonable in amount. Distributing profits as salaries and bonuses can help minimize taxable corporate income, although you and other recipients will be taxed individually on the compensation you receive.

You may decide that paying additional compensation is preferable to paying out profits as dividends. Unlike compensation, dividends are not deductible. Result: C-Corporate profits are taxed twice — once at the corporate level and again to the shareholders who receive the dividends.

A Word of Caution

If the amount of compensation paid to you and other shareholder-employees is deemed to be unreasonable, the IRS could challenge your company’s deduction for the expense, reclassifying the “excessive” amounts as nondeductible dividends. This applies to C-Corporations.

To potentially reduce the chances of problems with the IRS, consider these strategies:

  • Divide the profits and pay out a portion as bonuses. Leave enough money in the company to generate a small amount of taxable income.
  • When setting bonuses, avoid using ownership percentages to determine the amounts shareholders will receive, since that method suggests the payment of dividends.
  • Adopt and follow a formal compensation plan for executives that includes bonus payments based on meeting specified financial goals.
  • Earmark a portion of company profits for dividends. Individual shareholders will generally pay federal income tax on qualified dividends at a maximum rate of 20%, which is significantly lower than the maximum rate on compensation and other ordinary income.

What is reasonable compensation? The following factors must be considered :

  • The profession
  • Your specialty within the profession
  • Years of experience
  • Geographic area of business
  • Job responsibilities

Your tax situation, profession and circumstances are unique. Jeff Urbach, CPA and partner at Urbach & Avraham, CPAs is an expert is determining reasonable compensation. Jeff is also a CVA (Certified Valuation Analyst) and an ABV (Accredited in Business Valuations). Contact us for a consultation regarding your situation.

Choice of Business Entity

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When you start a business, there are endless decisions to make. Among the most important is how to structure your business. Why is it so significant? Because the structure you choose will affect how your business is taxed and the degree to which you (and other owners) can be held personally liable. Here’s an overview of the various structures.

Sole Proprietorship

This is a popular structure for single-owner businesses. No separate business entity is formed, although the 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. You report your business income and expenses on Schedule C, an attachment to your personal income tax return (Form 1040). Net earnings the business generates are subject to both self-employment taxes and income taxes. Sole proprietors may have employees but don’t take paychecks themselves.

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”). A one-member LLC is considered to be a “disregarded entity” by the IRS. Usually, income is taxed to the owners individually on Form Schedule C- Business Income (part of Form 1040), and earnings are subject to self-employment taxes. Note: It’s not unusual for lenders to require a small LLC’s owners to personally guarantee any business loans.

An LLC can make an election to be taxed as a corporation or a partnership by filing IRS Form 8832- Entity Classification Election.

Corporation

A corporation is a separate legal entity that can transact business in its own name and files corporate income tax returns. Like an LLC, a corporation can have one or more owners (shareholders). Shareholders generally are protected from personal liability but can be held responsible for repaying any business debts they’ve personally guaranteed. If you make a “Subchapter S” election, shareholders will be taxed individually on their share of corporate income. This structure generally avoids federal income taxes at the corporate level.

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.

Summary

There is no right or wrong entity. The question is which one is correct for your company, needs and circumstances. Call us for a consultation to help you select the appropriate entity form for your business and family.

Do a Financial Review Mid-Year

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Before you get involved with other things this late summer, schedule a mid-year checkup. No, we’re not talking about the height/weight/blood pressure kind of checkup, we’re talking about the income statement/balance sheet/cash flow kind of checkup — a review of your business’s financial operating fundamentals.

If you review your vital financial information only when year-end rolls around, you may not know there’s a problem until it’s too late. The more often you take your company’s “pulse,” the sooner you’ll be able to notice — and react to — changes in your business situation.

Check Your Vital Signs

What should you be looking at? Start with the operating fundamentals. For example, what’s the status of accounts payable? When’s the last time you ran an aging report for accounts receivable? How long are your A/R outstanding? How quickly is your inventory turning? What is your profit margin?

These numbers are critical to running your business. You can’t make accurate decisions if your figures are old. And, by keeping track of key financial ratios, you can more readily spot trends that should be addressed sooner rather than later. Your A/R should be reviewed by an appropriate attorney to verify that the language of your agreements and invoices covers you in case of slow or non-payers.

Monitor Your Budget

Next, check your spending. If overspending is a problem, creating a comprehensive budget that establishes realistic guidelines is an effective remedy. Make sure you have a budgeted amount for every line item expense on your operating statement. Then track and compare actual spending to budgeted amounts on a regular basis.

Certain expenses should be reviewed by a specialist to reduce expenses and verify adequate services. For example, business insurance should be reviewed with an insurance agent, bank and credit card charges with your banker, telephone expense with a communications expert.

Reduce Your Debt

Avoid the temptation to take out all your profits in good years. Instead, consider reinvesting some of those earnings in the business. Using retained earnings instead of debt to capitalize your business saves money — and provides a safety net that will be there to help you through periods of lackluster sales or unexpected expenses. Review your cash flow and investments with your investment adviser. A healthy debt-to-equity ratio will also look great when it’s time to borrow money or sell your business.

See a Specialist

Helping owners build and maintain healthy businesses is our specialty. Let’s schedule that mid-year review of your company’s finances soon.

To learn more about financial reviews give us a call today. In addition, we work with many competent insurance agents, investment advisers and collection attorneys who can review your operations.

New Tax Deduction for Owners of Qualified Businesses

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Good news for partnerships, S corporations, sole proprietorships, and estates and trusts

(pass-throughs) which can deduct  up to 20% of their Qualified Business Income (QBI) under new IRS Section 199(A).

What is Qualified Business Income? Qualified Business Income is net income that is received from a Qualified Trade or Business. Capital gains, and dividend and interest income are not considered business income. Guaranteed payments or wages paid to owners are excluded.
What is a Qualified Trade or Business? A Qualified Trade or Business is any trade or business that is not a “Specified Service Trade or Business” defined by the IRS as the following:
• businesses in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services,
• any banking, insurance, financing, leasing, investing, or similar business,
• operating a hotel, motel, restaurant, or similar business, and
• businesses involved in investing and investment management, trading, or dealing in securities

Income Limitation for Specified Service Trade or Businesses Owners of a Specified Service Trade or Business may take the QBI Deduction if their taxable income is below $157,500 for single filers ($315,000 for Married Filing Joint) to be eligible for the full deduction.

How is the QBI Deduction Calculated? The QBI Deduction usually is the smaller of 20% of the Qualified Business Income or 20% of taxable income. For example, a single self-employed lawyer has $150,000 of QBI. His taxable income is $138,000(below the income limitation). Therefore, his QBI deduction is $27,600, which is 20% of his taxable income.

Good news for staffing firms, and the real estate industry! The IRS proposed regulations clarify that the following businesses qualify for the QBI deduction with  no income limitation: staffing firms, real estate agents and the rental of tangible or intangible property to a related business. Other rental real estate properties may qualify if the activity rises to the level of a business.
Limitations for Qualified Businesses – these businesses have no income limitations but may be limited based on the business’s W-2 wages and unadjusted basis in qualified property. The amount of the tax deduction will vary depending on the specific taxpayer circumstances.
Want to maximize your deduction? Whether your business is a Qualified Business or a Specified Service Trade or Business and regardless of your income level, there are numerous tax moves one can do to maximize this new Sec 199(A) deduction- even for 2018! Please consult with us about your situation.

Avoid Paying Corporate Income Tax Rates with an S Corporation

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One reason small business owners like the S corporation tax structure is because profits generally aren’t taxed at the corporate level.

Tax Savings

They “pass through” and are taxed only once to the individual shareholders. S corporation shareholders also can take money out of the company free of federal employment and self-employment taxes. But only up to a point.

Put Yourself on the Payroll

It can be tempting for S corporation owner/employees to underpay themselves to keep employment taxes low and then supplement their income with distributions or other payments that aren’t subject to employment taxes.

But the IRS is on the lookout for owners reporting low or no income. So if you’re an owner/employee, make sure your compensation is “reasonable” for the services you provide. If it isn’t, the IRS may reclassify your “other” compensation as salary and assess a stiff penalty (100% of the unpaid taxes) for failure to remit payroll taxes.

Comparable Is Key

There is no set definition of reasonable compensation. However, you can be reasonably certain that such factors as your duties and responsibilities, how much time and effort you put into your business, and how much training and experience you’ve had should be included when determining your compensation. To get an idea of how much similar businesses are paying for comparable services, you can go to www.bls.gov, a website with salary information hosted by the U.S. Bureau of Labor Statistics.

The topic of S corporation compensation has become an IRS audit issue. Avoid problems by paying yourself a reasonable salary.

For more help with individual or business taxes, connect with us today. Our team can help you with all your tax issues, large and small.

Home Office Tax Tips

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Working from home can potentially deliver some attractive tax advantages.

Your New Home Office!

If you qualify for the home office deduction, you can deduct all direct expenses and part of your indirect expenses involved in working from home.

Direct expenses are costs that apply only to your home office. The cost of painting your home office is an example of a direct expense. Indirect expenses are costs that benefit your entire home, such as rent, deductible mortgage interest, real estate taxes, and homeowner’s insurance. You can deduct only the business portion of your indirect expenses.

What Space Can Qualify?

Your home office could be a room in your home, a portion of a room in your home, or a separate building next to your home that you use to conduct business activities. To qualify for the deduction, that part of your home must be one of the following:

Your principal place of business. This requires you to show that you use part of your home exclusively and regularly as the principal place of business for your trade or business.

A place where you meet clients, customers, or patients. Your home office may qualify if you use it exclusively and regularly to meet with clients, customers, or patients in the normal course of your trade or business.

A separate, unattached structure used in connection with your trade or business. A shed or unattached garage might qualify for the home office deduction if it is a place that you use regularly and exclusively in connection with your trade or business.

A place where you store inventory or product samples. You must use the space on a regular basis (but not necessarily exclusively) for the storage of inventory or product samples used in your trade or business of selling products at retail or wholesale.

Note: If you set aside a room in your home as your home office and you also use the room as a guest bedroom or den, then you won’t meet the “exclusive use” test.

Simplified Option

If you prefer not to keep track of your expenses, there’s a simplified method that allows qualifying taxpayers to deduct $5 for each square foot of office space, up to a maximum of 300 square feet.