Categories
Federal Income Tax

Small Business Form 1099 Requirements

Who needs to file a 1099?

A 1099 is a form that a business or non-profit (both referred to as businesses for the rest of this post) files to inform to both IRS and one of their vendors of the amount of reportable payments that the business made to them during the year. Most Forms 1099 are due by January 31, 2018, although it is possible to extend the date for filing with the IRS by 30 days.  Payee copies remain due January 31.  .

Form 1099 is a business form, so payments made for personal purposes do not need to be reported. Payments made to corporations also don’t usually need to be reported.  Most small landlords do not need to file form 1099, but there has been some confusion about that which is discussed in a separate post.

Businesses need to report several different kinds of payments made to non-corporate payees, but the two most commonly overlooked are rent and non-employee compensation. Basically any time a business makes six hundred dollars or more in reportable payments during the calendar year to one payee, they need to file form 1099.  Payments made to pay for legal or medical expenses for business purposes need to be reported on form 1099, even if made to a corporate payee.

 

Timely Filing More Important than Ever Before

Although congress repealed the provisions of the 2010 which would have expanded the categories of payments that need to be reported and who needs to report them, it did not repeal the increased penalties for failing to file a 1099 when required.  Small businesses, defined as businesses with gross receipts below $5,000,000 per year, have lower penalties for late 1099s than larger businesses.  For small businesses, the penalty for failing to file a 1099 with the recipient or the IRS by their respective due-dates is now $50 if less than 31 days late.  If more than 30 days late, the penalty becomes $100 for the payee copy and $100 for the IRS copy as long as the forms are filed by August 1.  Forms 1099 filed after August 1 incur a penalty of $260 per return, and intentional disregard of the rules can result in penalties of $530 per return.  Additionally, the IRS has added questions to schedule C, schedule E, and the corporate and partnership tax forms which ask if the taxpayer is required to file form 1099, and if they have done so (IRS).  This essentially compels taxpayers who may be filing their income tax returns in March or April to turn themselves in if they forgot to file 1099s in January

1099s for Rent Paid

Businesses don’t always realize when a 1099 is required, and 1099s for rent are especially problematic. Rents payed to a single payee for business proposes must be reported if the total rents payed to that person exceed $600 for the year. Rents paid to a real estate agent do not need to be reported on a 1099, but the agent must file form 1099 to report report the amounts collected and remitted to a landlord. Self-rental income must also be reported on form 1099.   Paying rent to the shareholder can be a great way to get cash out of a closely-held corporation, but many small businesses fail to file a 1099 to report that income.

1099s for Non-employee Compensation

Businesses sometimes run into trouble when it comes time to issue 1099s because they haven’t gathered the information that they needed to during the year.  For example, they may not have asked a contractor for his or her employer ID number or social security number at the time when services were provided, they may not even have gotten an address where they should send the 1099 to, or they may not have maintained a list of which vendors are individuals or partnerships and which are corporations.

It’s a good idea when hiring a vendor for any sort of service to ask if they are incorporated, and to collect their name, address, and employer ID number or social security number.  Some accounting programs, such as QuickBooks, include all of the necessary fields in the vendor record, and also include a check box that can be marked to indicate that the vendor needs a 1099.  If this information is captured when the vendor is hired, then the company can quickly and easily print a report with all of the information they need to file their 1099s at year-end.

Keep in mind that a company cannot avoid payroll taxes or other obligations by classifying a worker who should be considered an employee as an independent contractor.

 

RESOURCES

Hill, Claudia.  (2013, March 6). Should Landlords be Filing 1099s for Service Providers. Forbes.com.  Retrieved 6, January, 2014 from http://www.forbes.com/sites/irswatch/2013/03/06/should-landlords-be-filing-1099s-for-service-providers/

Internal Revenue Service.  (2018).  Increase in Information Return Penalties https://www.irs.gov/government-entities/federal-state-local-governments/increase-in-information-return-penalties-2

Internal Revenue Service.  (2018).  Instructions for Form 1099-Misc. Retrieved from  http://www.irs.gov/pub/irs-pdf/i1099msc.pdf

 

 

Categories
Federal Income Tax

Keep Real Estate Out of Your Corporation

Including the wrong kinds of assets in a corporation can be an expensive mistake. Things that are worth more over time, like investments, collectibles, and especially real estate, should be kept out of a closely-held corporation.  This mistake costs more for C-corporations than for S-corporations, but even  S-corps should be cautious about what assets they hold.  Business real estate is generally best owned personally, in a single-member LLC, or in an LLC taxed as a partnership.

Real Estate in C-corporations

A family’s biggest asset is usually its home, and a business’s biggest asset is usually its real estate.  This might be the corporate offices, a workshop, a garage, or retail space.  It may seem normal that a business would own its own building, but that’s often a bad idea.  Closely held corporations usually shouldn’t own any kind of real estate.  If a small business needs real estate, the shareholder should buy it, not the corporation.  Here’s why:

Photo of 384 Court Street Auburn, ME 04210

If the corporation is organized as a C-corporation, the profits get taxed twice.  Any business profits are taxed at the corporate level, and then taxed again when they’re paid out to the shareholder as a dividend.  If a company owns its real estate, it probably bought it because owning was be cheaper than renting.  That means that owning the property drives up the amount of income that gets taxed twice.

The opposite happens when the shareholders own the real estate.  When the shareholder owns the real estate, the rent expense is a deduction for the corporation and the shareholder’s rental profits are only taxed once.  The business can’t pay more than market rent for the space, but paying rent near the high end of the market is a great way to get money out of a c-corp.

Owning land or buildings inside the corporation might be a minor mistake while the business is operating, but it can be a disaster when the owner retires.   With a little bit of luck, retirement means usually means selling the business for lots of money.  If a buyer can’t afford the property or wants to move the business, the shareholder can be stuck owning an empty building in the corporation or renting it out.  This creates an ongoing tax and paperwork burden that would be much easier if the real estate was held personally.

The real pain comes when the shareholder sells the property.  C-corps don’t get capital gains rates, so selling the corporate real estate can quickly drive the corporation’s income into the higher tax brackets.  How big a of a a problem is that?

It’s a big one.  With a top marginal rate of 39% kicking in for corporate incomes between $100,000 and $335,000, and a top Maine corporate tax rate of 8.93%, a C-corp shareholder who sells property inside of the corporations might lose 40% of their gains to taxes before they even get the money out of the company.

 

Withdrawing the after-tax profit from the corporation will trigger a federal tax on dividends as high as 20%.  For Maine residents, the state taxes top out at 7.15%.  For a high-income shareholder, the dividends could also be subject to new federal Net Investment Income Tax of 3.8%.  Altogether, this means that a corporate shareholder might be left with as little as 42% of his or her gains.  This is all just because the shareholder made the wrong decision about how to buy the property corporation decades earlier.  These estimates simplify a few things, but are ballpark accurate.

If that same shareholder had held the building in his or her own name and leased it to the corporation, the profits from selling the building would only be subject to capital gains tax, ordinary income tax on depreciation recaptured, and state income tax.  2013 regulations clarify that gains from selling real estate that is rented to a shareholder’s active trade or business will not be subject to the net investment income tax.  Therefore, the same shareholder who would lose 58% of his or her real estate gains to taxes if the building were held by the corporation might pay less than half of that in taxes if the building were held personally.

Real Estate in S-Corporations

S-corporations don’t pay tax at the shareholder level.  Owning property in an S-corp isn’t as bad, but even S-corporations should still keep real estate in the shareholder’s name.

 

Holding real estate inside of an S-corporation can create problems when a shareholder joins or leaves the business.  Imagine that one shareholder is running a business and someone else wants to buy-in and run it with them.  If the business owns the real estate, the new shareholder needs to come up with enough money to by their share of the business and their share of the property at the same time.  If the shareholder owned the land or buildings, the new shareholder could buy stock in the business now, and wait years before buying the property it occupies.    This makes it easier for new owners to buy-in to the operating business because they don’t have to come up with payment for their share of the real estate value at the same time as their share of the business value.

Even sole-shareholder can run into problem with real estate in his or her S-corporation when they go to sell their business or when it makes sens for the business to move on to a new location.  The shareholder can’t re-purpose the real estate for personal use without triggering a taxable event, and if he or she sells the business, the new owner may not want the real estate to go with it.

Conclusion

Avoid tax headaches by keeping real estate out of your closely-held corporation.  Any corporation thinking of buying real estate in its own name should talk to its tax professional, and any tax pro worth his or her salt will probably have one piece of advice.  “Don’t do it”.

 

 

Categories
Federal Income Tax

Identity Verification Letters (IRS 5071C)

Have you received an identity verification letter from the IRS??  While there are always a lot of scammers trying to impersonate the IRS, the IRS does send identity verification letters out to some taxpayers.  Real identify verification contacts will always come by paper mail.  are never sent by telephone or e-mail.  A real identity verification request will identify itself as IRS letter 5071C.  The only site a legitimate Letter 5071C will direct the taxpayer to is idverify.irs.gov.  For more information, see the article on Forbes and the IRS page about letter 5071C.

When a taxpayer gets one of these letters, it means that the IRS has received a tax return their information on it and needs to verify the taxpayer’s identity before it finishes processing the return.   Taxpayers need to respond to these identity verification letters promptly or their refunds will be delayed.  Taxpayers should also never give out information that an identity thief could use to impersonate them, unless they are absolutely certain that they are talking to the IRS.  When in doubt, call the number for telephone assistance for individuals, 1-800-829-1040, to verify that the contact did actually come from the IRS.  To be doubly certain, they can verify that it is telephone assistance number listed on the IRS Telephone Assistance page.

This year (2015) in particular, there has been a definite increase in identity theft and tax return fraud.  The increase in fraud has affected both federal and state returns.  One major tax software company even had to suspend e-filing of state tax returns because it was being used to file so many fraudulent returns.

To read further about IRS identity verification and the IRS’s efforts to fight identity theft, visit their Identity Protection resource page.

 

 

Categories
Federal Income Tax

Don’t incorporate too early!

The decision to incorporate is often one of the first choices new business owners makes, even before they’ve drafted a business plan or secured start-up capital.  In many cases, this can turn out to be a costly mistake.  While it’s true that incorporating a profitable business can sometimes yield tax savings, most businesses lose money during their start-up years and some businesses never manage to become profitable.  Most of the time, these start-up period losses would be more valuable on the owners’ individual income tax returns than they would be on a corporate tax return, and winding-down a business that has been incorporated can be much more expensive than winding-down a business that has never been incorporated. Here are some questions that the business owners should ask themselves before they form a corporation or other legal business entity:

  • What benefit will the business get from incorporating?
  • When will the business become profitable?
  • Does the business include real estate or other property that is likely to increase in value?
  • Where will the money to start the business come from?

Why incorporate?

Sometimes business owners will incorporate just because they think it’s something that people do when they start a business or because they think that they can convert expenses that wouldn’t be deductible without incorporating into business deductions by paying for them as a corporation.  The first is generally not true, and the second is almost always wrong.  A business can operate indefinitely and never  incorporate, and there are very few things that are deductible as a corporation that are not also deductible for an unincorporated business.

 

Corporations do offer tax savings to some businesses, but for a different reason.  A corporation can choose to be either a “C-corporation” or an “S-corporation”.  Both types of corporation can offer tax savings by reducing self-employment taxes. C-corporations have their own set of tax brackets separate from their owners.  C-corporation earnings are not subject to self-employment tax and the first $50,000 of taxable income in a C-corporation each year is taxed at a 15% rate,  but corporations don’t receive a standard deduction or personal exemptions.   This can make  C-Corporation very attractive for business owners when their companies are profitable and retaining some of the earnings to pay for future growth.  They are generally less desirable for business owners who typically take all of the earnings from their companies or each year to pay for personal expenses because these retained earnings cannot be withdrawn forum a C-corporation without being taxable to the owners as dividends.

 

S-corporations don’t offer income tax savings because all of their earnings get reported and taxed on their shareholders’ returns, but they can reduce self-employment taxes.  Unlike an LLC with an operating business, S-Corp profits are not subject to self-employment tax, and unlike a C-corporation,  S-Corp earnings can be withdrawn without a second level of tax. The tax code requires corporate shareholders who work for their companies to receive adequate compensation in the form of a salary or wages subject to payroll tax.  Because S-Corp earnings are not subject to corporate income tax or self employment tax, the IRS reserves the right to reclassify distributions or other payments to shareholders as wages if adequate wages are not paid.

 

Questions about legal liability should be directed at attorneys rather than accountants, but a common reason to incorporate is for liability protection.  A sole proprietor is generally on the hook for any debts incurred by his or her business, including debts that could result from a business-related accident.  Operating as a corporation or an LLC can offer a degree of protection for the shareholders’ personal assets if the businesses is unable to pay its bills.

Why not to incorporate

While there can be some very good reasons to operate a business as a corporation,  there are also a lot of good reasons not to.   Corporations have more tax filing and administrative burdens than unincorporated businesses.   Business losses from an unincorporated business often yield more tax savings than similar losses inside of a corporation.   Additionally, property can generally be placed in a corporation without a tax cost but usually can’t be taken out without the shareholder having to recognize taxable income.    These disadvantages tend to be greatest early in a businesses life.

 

First,  the paperwork burden of a corporation is more than most business owners can handle without paying for outside help.  Corporations must file income tax returns separate from their owners.  Even if the shareholder is the only employee, a corporation must file payroll tax returns and collect and remit payroll taxes and income tax withholding on the shareholders compensation from the corporation.   Most states require corporations to file an annual report each year to remain in good standing and keep its legal protection.  Finally,  a corporation generally needs to hold annual meetings, maintain minutes, and keep other records that just don’t apply to unincorporated business.

Second,  losses in a corporation are often worth less than losses in an unincorporated business.   This author has seen more than one case where a married taxpayer starts a business and runs losses for the first several years.  Self-employment losses not only reduce taxable income, but also earned income and adjusted gross income.   Sometimes this can result in an earned income credit, even when the wage-earning  spouse earns more than the earned income credit phase out.  The deduction of losses from AGI also helps taxpayers with other income avoid the AMT and claim other deductions and credits that are unavailable to high income taxpayers.

Finally,  the tax laws surrounding incorporation are basically a one-way deal.   the owners of a corporation can add assets to it all day long without incurring a tax,  but most withdrawals from a corporation will be taxed as salaries or dividends.  When a shareholder takes something other than money out of his or her business, the IRS considers the property to be sold for whatever it is worth and the cash distributed.  This can result in tax for both the shareholder and the corporation.

New Businesses Hit Hardest

Operating as a corporation can save a business money on income taxes and give it’s owners some liability protection but incorporating too soon can cause an unnecessary burden and unexpected tax costs.   The benefits of incorporating are greatest for profitable,  established businesses.   New businesses that are just starting our are often better off staying sole-proprietors for a while.

 

 

photo credit: Tyler Merbler via photopin cc

Categories
Charitable Contributions Federal Income Tax

Contributions for Specific Individuals

The tax code doesn’t allow a charitable contribution deductions for gifts made for a specific individual.  This is true even when a qualified charity collects the donation for the individual.  Donations made directly to a member of the clergy to be used for their own purposes are also not deductible.  Sadly, this restriction also extends to the payment of medical or other expenses for a needy individual.

Whether or not a contribution is deductible shouldn’t be the last work in whether or not to make a contribution.  Keep in mind that a portion of most donations made to charitable organizations has to be spent on overhead.  When a donation is made directly to someone in need presumably 100% of the donation amount goes to helping them.  That means you can  often do as much good with a non-deductible contribution to an individual as you could with a gift to a church or non-profit group.  Just don’t make the mistake of deducting it on your taxes.

The person who inspired this post is Wynter Przybylski, the 7-year-old daughter of a high school friends and the subject of a recent Bangor Daily News article.  Wynter is battling childhood leukemia and the Pryzbylski’s have a page up seeking donations to help with her care.  I’ve included a couple of links about Wynter’s story below.  The donations they receive for this are not tax-deductible, but can do a lot of good!

http://bangordailynews.com/2014/04/12/news/bangor/community-rallies-behind-brewer-girl-battling-cancer/

http://wabi.tv/2014/04/09/brewer-girl-fighting-leukemia-finds-community-support/

http://www.youcaring.com/medical-fundraiser/cancer-messed-with-the-wrong-girl/154540/update/150281

 

photo credit: N08/6510934443/”>asenat29 via photopin cc