If you’re a business owner and your company lends you money, you’ll enter it in the books as a shareholder loan. However, if your return is audited, the IRS will scrutinize the loan to see whether it is really disguised wages or a dividend taxable to you as income.
Knowing what the IRS might look at may be useful when you structure the arrangement. Here are some items that will be considered if you’re audited:
Your relationship with the business. First, the IRS will look at your relationship to the company. If you’re the sole shareholder with full control over earnings, that may weaken your case that the loan is genuine. On the other hand, if you’re one of several shareholders and none of the others received similar payments, that suggests it may be a genuine loan.
Loan details. The IRS will want to know all the details related to your loan. This may include whether or not you signed a formal promissory note, if you pledge any security against the loan and if the loan has a specific maturity date or a repayment schedule. Other questions may come up about the rate of interest you’re paying and if you missed any payments. The more businesslike the terms of the loan, the more it will appear to be a genuine debt.
Other financial details. In addition to loan specifics, the IRS may ask you if your company is paying you a salary that’s in line with the work you perform, and if the company pays dividends.
Whether the IRS taxes you on the loan will depend on all these factors. If you’ve paid attention to the details, the loan should withstand IRS scrutiny. Contact us if you’d like more information about getting a loan from your business.
IRS audit rates declined last year for the sixth year in a row and are at their lowest level since 2002, the agency reported. That’s good news for people who don’t like a IRS audit (which is everybody)!
Low statistics for audit examinations obscure the reality that you may still have to deal with issues caught by the IRS’s automated computer systems. These could be math errors, typos or missing forms. While not as daunting as a full audit, you need to keep your records handy to address any problems.
Average rates are declining, but audit chances are still high on both ends of the income range: no-income and high-income taxpayers.
No-income taxpayers are targets for audits because the IRS is cracking down on fraud in refundable credits designed to help those with low income, such as the Earned Income Tax Credit (EITC). The EITC can refund back more than a low-income taxpayer paid in, so scammers attempt to collect these refund credits through fraudulent returns.
High-income taxpayers have increasingly been a target for IRS audits. Not only do wealthy taxpayers tend to have more complicated tax returns, but the vast majority of federal income tax revenue comes from wealthy taxpayers. Based on the statistics, the very highest income taxpayers can assume they will be audited about every six years.
Complicated returns are more likely to be audited. Returns with large charitable deductions, withdrawals from retirement accounts or education savings plans, and small business expenses and deductions are reportedly more likely to be the subject of an audit.
Like it or not, you must learn how to delegate work to your employees. It’s easy to get in the mindset that if you want things done the right way you have to do them yourself. But that isn’t always the best approach at work, even if you firmly believe you’re the best person for the job. There simply isn’t enough time in the day, especially if you have a business to run.
Here are some helpful hints:
Develop a game plan. Start by deciding which tasks to delegate and which employees will be assigned responsibilities. The workload doesn’t have to be etched in stone, but you need a basic plan to subdivide jobs.
Find your most reliable, autonomous employees. You will need to rely on people who can think for themselves. Don’t rely on employees who you anticipate will be constantly seeking your guidance. If you have to show someone what to do every step of the way, it defeats the entire purpose.
Don’t hinder your employees. Give them the authority to act independently and make decisions on the fly. Don’t hinder the process by requiring employees to obtain your approval on every decision. This will only turn into a variation of doing things the same old way.
Keep track of work progress. This aspect must be handled with sensitivity. You’ll want to keep an eye on employees, but you can’t keep looking over their shoulders either. Find the proper balance.
Analyze the results. Do this to determine if the work met your expectations. If it didn’t, offer constructive criticism for improvements. Make this a learning experience for both of you.
As you become more comfortable delegating work, you can continue to loosen the reins. When you spend less time on routine matters, you’ll have more time to devote to growing your business profits.
If you’re a business owner, one of the first questions to ask yourself is whether you should incorporate or not.
The biggest advantage of incorporating is that it limits your legal liability. Your responsibility for debts and other liabilities incurred by a corporation is generally limited to the assets of the business. Your personal assets are not usually at risk, although there can be exceptions to this general rule. The trade off is that there is a cost to incorporate and, in some cases, tax consequences.
So, should you incorporate or not?
Truth be told, you might not need to incorporate. Depending on the size and type of your business, liability may not be an issue or can be covered by insurance. If so, you could join millions of other business owners and operate as an unincorporated sole proprietor.
If you do decide to incorporate, you’ll face a choice of corporate forms. All offer limitation of your liability, but there are differences in tax and other issues. Take a look at the options:
C corporations. The traditional form of corporation is the C corporation. This type of corporation has the most flexibility in structuring ownership and benefits. Most large companies operate in this form. The biggest drawback is double taxation. First the corporation pays tax on its profits; then the profits are taxed again as they’re paid to individual shareholders as dividends.
S corporations and LLCs. These forms of corporations avoid this double taxation. Both are called “pass-through” entities because there’s no taxation at the corporate level. Instead, profits or losses are passed through to the shareholders and reported on their individual tax returns. S corporations have some ownership limitations. There can only be one class of stock and there can’t be more than 100 shareholders who are U.S. citizens or U.S. residents according to tax law. State registered LLCs have become a popular choice for many businesses. They offer more flexible ownership rules than S corporations, as well as certain tax advantages.
Whether you’re already in business or just starting out, choosing the right form of business is important. Even established businesses change from one form to another during their lifetime.
Call our office (and your attorney) for guidance in selecting the form that is best for your business.
Starting your own business can be equal parts thrilling and intimidating. Complying with regulations and tax requirements definitely falls into the latter category. But, with some professional help, it doesn’t have to be that way. You can get started with this checklist of things you’ll need to consider.
Are you a hobby or a business? This may seem basic to some people, but the first thing you’ll have to consider when starting out is whether you really are operating a business, or pursuing a hobby. A hobby can look like a business, but essentially it’s something you do for its own sake that may or may not turn a profit. A true business is generally run for the purpose of making money and has a reasonable expectation of turning a profit. The benefit of operating as a business is that you have more tax tools available to you, such as being able to deduct your losses.
Pick your business structure. If you operate as a business, you’ll have to choose whether it will be taxed as a sole proprietorship, partnership, S corporation or C corporation. All entities except C corporations “pass through” their business income onto your personal tax return. The decision gets more complicated if you legally organize your business as a limited liability corporation (LLC). In this case you will need to choose your tax status as either a partnership or an S corporation. Each tax structure has its benefits and downsides – it’s best to discuss what is best for you.
Apply for tax identification numbers. In most cases, your business will have to apply for an employer identification number (EIN) from both the federal and state governments.
Select an accounting method. You’ll have to choose whether to use an accrual or cash accounting method. Generally speaking, the accrual method means your business revenue and expenses are recorded when they are billed. In the cash method, revenue and expenses are instead recorded when you are paid. There are federal rules regarding which option you may use. You will also have to choose whether to operate on a calendar year or fiscal year.
Create a plan to track financials. Operating a business successfully requires continuous monitoring of your financial condition. This includes forecasting your financials and tracking actual performance against your projections. Too many businesses fail in the first couple of years because they fail to understand the importance of cash flow for startup operations. Don’t let this be you.
Prepare for your tax requirements. Business owners generally will have to make quarterly estimated tax payments to the IRS. If you have employees, you’ll have to pay your share of their Social Security and Medicare taxes. You also have the obligation to withhold your employees’ share of taxes, Social Security and Medicare from their wages. Your personal income tax return can also get more complicated if you operate as one of the “pass-through” business structures.
This is just a short list of some of the things you should be ready to discuss as you start your business. Knowing your way around these rules can make the difference between success and failure, but don’t be intimidated. Help is available so don’t hesitate to call if you have any questions.
Emotions make us human. They can also cause us to make rash decisions. Business owners and managers often let emotions dominate the decision-making process. This is especially true when choices are based on “sunk costs.”
Why sunk costs can lead to trouble
Broadly defined, sunk costs are past expenses that are irrelevant to current decisions. For example, many firms hire consultants who sell and install software. In some cases, a company is left waiting for years for a functional and error-free system. Meanwhile, costs continue to escalate. But are those costs relevant?
Managers, especially those who initially procured the software and contractor, may reason that pulling the plug on a failed contract would be wasting all the money spent. Not true. That money is “sunk.”
Other examples of sunk costs may be found in the areas of product research, advertising, inventory, equipment, investments and other types of business expenses. In each of these areas, companies spend money that can’t be recovered — dollars that become irrelevant for current decision-making.
Sunk costs are a waste of time — move on
Truth be told, the only relevant costs are those that influence the company’s current and future operations. Throwing good money after bad won’t salvage a poor business investment — or a poor business decision.
